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HOW TO CHOOSE WINNING STOCKS

HOW TO CHOOSE WINNING STOCKS

R e w r i t i n g F o r m u l a s f o r I n v e s t m e n t

G.B.R.K. Prasad

Copyright © G.B.R.K. Prasad, 2010

All rights reserved. No part of this book may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopy-ing, recording or by any information storage or retrieval system, without permission in writing from the publisher.

First published in 2010 by

Response BooksBusiness Books from SAGEB 1/I-1 Mohan Cooperative Industrial AreaMathura Road, New Delhi 110 044, India

Sage Publications Inc2455 Teller RoadThousand Oaks, California 91320, USA

Sage Publications Ltd1 Oliver’s Yard, 55 City RoadLondon EC1Y 1SP, United Kingdom

Sage Publications asia-Pacific Pte Ltd33 Pekin Street#02-01 Far East SquareSingapore 048763

Published by Vivek Mehra for SAGE Publications India Pvt Ltd, typeset in 10.5/13 pt. Baskerville BE Regular by Innovative Processors, Delhi and printed at Chaman Enterprises, New Delhi.

Library of Congress Cataloging-in-Publication Data

Prasad, G.B.R.K. (Garapaty Balarama Krishna), 1960–How to choose winning stocks: rewriting formulas for investment/G.B.R.K. Prasad.

p. cm.Includes index. 1. Investments. 2. Investment analysis. I. Tittle.

HG4521.P74 332.63'22—dc22 2010 2010003005

ISBN: 978-81-321-0440-7 (Pb)

The Sage Team: Reema Singhal, Anupam Choudhury, Anju Saxena and Trinankur Banerjee

Dedicated to the holy lotus feet of Samarth Sadguru

Shri Shirdi Sai Baba Garu

C o n t e n t s

List of Tables ix

List of Figures xi

Foreword by C.S. Gopinath xiii

Preface xv

Acknowledgments xvii

List of Abbreviations xix

1 Introduction 1

2 Valuation Ratios Related to Market Capitalization 26

3 Analysis of EPS and Assets Per Share Model 49

4 Assessing Indebtedness of a Company 61

5 Identifying Companies Based on Quarterly Results 66

6 Sector-wise Profitability Analysis 70

7 Mutual Funds 83

8 Unconventional Ratios for Identifying Stocks 97

9 General Suggestions Compiled from the Available Literature 102

Index 109

About the Author 112

L i s t o f T a b l e s

1.1 Value of UK Sterling Pound 100 Invested in 1945, Gross Income Reinvested 8

1.2 Value of UK Sterling Pound 100 Invested in 1990, Gross Income Reinvested 8

1.3 Profit and Loss Statement of XYZ Company for the Year Ended March 2009 9

1.4 Balance Sheet of XYZ Company as on 31 March 2009 10

1.5 Cash Flow Statement 12 1.6 Ratio Analysis 13 1.7 Data Analysis for Various Companies as per

Dividend Yield Model 201.8 Movement of P/E Ratios of Stocks Identified 24

2.1 Analysis of Scenarios of MCAP/Sales Ratios 27 2.2 Basis for Investment Logic Using MCAP/Sales Ratio 28 2.3 Companies Sorted Out on the Basis of MCAP/Sales 30 2.4 NPM and P/E Ratio for Nifty Basket of Companies 34 2.5 Examples of High NPM and Low P/E Ratio for

Competing Companies 38 2.6 Risk Assessment of Investments Using ROCE

Approach 39 2.7 ROCE vs P/E Ratio 40 2.8 Companies Sorted on the Basis of MCAP to

Assets Ratio 45

3.1 Nifty Basket of Companies with EPS Details 50

x | H o w t o C h o o s e W i n n i n g S t o c k s

3.2 ET-Lifex Basket of Companies 53 3.3 CPS Analysis of Select Stocks 56 3.4 Analysis of Companies wherein Dividend is High

and Assets Per Share is Low 57

4.1 Capital Employed/Net Worth Data 61

5.1 Analysis of OPMs of Select Companies 67

6.1 Number of Companies in Key Sectors in India 70 6.2 OPM Analysis of Key Sectors 73 6.3 Summary of Parameters to Judge Overall Heatedness

of the Stock Market 81 6.4 Variation in FII Holdings Status 82

7.1 Mutual Fund Schemes in India 87 7.2 Balanced Funds Analyzed 91 7.3 Mid Cap Funds Analyzed 93 7.4 Mutual Funds Analysis—Dividend and Growth

Options 94

8.1 ROCE vs P/E Ratio of Select Companies 97 8.2 Growth Rates Data of Select Companies 99

9.1 Bull Market vs Bear Market 106

L i s t o f F i g u r e s

2.1 NPM vs P/E Ratio: Illustration 1 36 2.2 NPM vs P/E Ratio: Illustration 2 36 2.3 NPM vs P/E Ratio: Illustration 3 37 2.4 NPM vs P/E Ratio: Illustration 4 37 2.5 ROCE vs P/E Ratio: Illustration 1 42 2.6 ROCE vs P/E Ratio: Illustration 2 42 2.7 ROCE vs P/E Ratio: Illustration 3 43 2.8 ROCE vs P/E Ratio: Illustration 4 43

3.1 NPM vs Sales per Share: Illustration 1 52 3.2 NPM vs Sales per Share: Illustration 2 52

7.1 Growth of Mutual Funds Industry in India 84 7.2 Number of Schemes of Mutual Funds 84

F o r e w o r d

T his book owes its inspiration to many investors who have been trying so hard to know the basics of investing in equity.

It brings together and synthesizes recent technical analysis with basic fundamental analysis. Such a book is necessary because the basic analysis of the stocks and interpretation of these stocks in the current market scenario represent a compilation of extensive knowledge to which readers may not have been exposed.

This book is an explanation of the author’s work which will allow a healthy reader to make intelligent decisions about investing in equities. Readers are advised to use it to have a clear understanding of equity instruments and the way to look at the valuations of the equity stocks. The guidance given by the author provides immense opportunity for investors to hone their skills for investing in equities.

C.S. gopinathSenior Vice President

Zonal Head for Andhra Pradesh and ChennaiHDFC Bank

Hyderabad

P r e f a c e

T his book has taken shape out of the personal analyses carried out by the author during 2004–2007 for his investment

planning and the research has been based on data gathered from Business Standard, Capital Market, and such. Wherever possible the reference dates have been mentioned, but some tables have been presented without the dates. Any errors in the data reported are not intentional or meant to misguide anyone, and are sincerely regretted. This book, which is a unique attempt spread over a period of three years, aims to share investment research methodology with one and all. Considering its objective, any errors in the analyses are sincerely regretted. The author or the publisher do not hold any responsibility for investments made based on the suggestions in this book and the reader is well advised to use his/her judgment in taking investment decisions, which may have prospects for advancement or losses depending on the market conditions which are very dynamic.

A c k n o w l e d g e m e n t s

I t is my pleasure to acknowledge all those who helped me in writing this book. First, I would like to thank my wife,

Sujatha, and daughter, Anusha, who have contributed a lot in this effort and helped me in preparing this book. My parents, G. Suryanarayana and G. Lakshmi Sarojini, played a vital role that needs special mention as they were instrumental in motivating me to complete the book while meeting the pressure of work at office. I want to express my sincere thanks to G. Sudha for her patient reading of the book and coming up with novel ideas to make it more presentable.

Last, I thank Y. Ramalingeswara Rao for helping me prepare the manuscript.

L i s t o f A b b r e v i a t i o n s

CEMP Capital EmployedDiv DividendNPM Net Profit MarginMCAP Market CapitalizationROCE Return on Capital EmployedROE Return on EquityEPS Earnings Per Share R&D Research and Development OPM Operating Profit MarginFII Foreign Institutional InvestorUTI Unit Trust of IndiaIMFI Indian Mutual Fund IndustryNAV Net Asset Value

1Introduction

I nvestments in stock markets have attracted the mighty and the low equally well. It is not the level of intelligence but the ability

to spot trends and apply common sense that has made many individuals rich in their own rights. Fortunes fluctuate and there is no decisive science to this subject. This book is an attempt to develop a methodology and systematize the effort involved in the art of investing in a scientific fashion based on the experiences of the author and the approach practiced by him. This book aims at generating a supplementary income for the investor who pursues this as a part-time activity in addition to his main professional interest. Therefore, full-time investors are advised to adopt more rigorous tools taught in business schools; however, the layman and the part-time investor can make decent gains by adopting this approach of systematically evaluating options and picking the right one to place bets on. The readers are advised to keep booking profits once they practice this approach because of the uncertainty of markets. There is no real target price to book profit—it depends on the market conditions and profitability of the company in question and various other economic conditions as well as the herd mentality found in stock markets these days. Some of the basic definitions of terms are given subsequently to refresh the naïve reader and to facilitate a better appreciation of the concepts.

2 | H o w t o C h o o s e W i n n i n g S t o c k s

The driving forces of stock markets of today and yesteryears have been the same underlying factors as put forth by many. They are:

Fear Greed Mass psychology Mania making Now, in today’s technology world, media coverage of the

events Last, the most neglected fundamentals of investments: ° Expected growth rate of economy ° Expected growth rate of company’s profits

There are many advocates of various driving forces, and the foremost are Benjamin Graham and Warren Buffett who have advocated the last of the above driving forces, such as the fundamentals of company and investing based on value-based philosophy.

While it is possible to make money with other driving forces if you are on the right side of the coin, what is not realized is that underlying forces of the market are the fundamentals that drive the market. For example, the mania witnessed for Japanese stocks in the 1980s and the technology stocks later on are classic examples of how markets go crazy with investor behavior and how reputed opinion gets formed about the stocks with everyone agreeing on the themes and creating a buying pressure for the theme stocks.

This book covers only the driving force of fundamentals of a company and prescribes an approach based on analyzing the fundamentals of the investment principles by examining the relationship between various entities in valuation, thus deriving a common sense approach to investments based on value principle as advocated by Benjamin Graham and Warren Buffett. While it should be remembered that this prescribes evidence-based systematic analysis of factors that influence a stock price movement based on fundamentals of a company, various approaches described in the book are tools of analysis to arrive

I n t r o d u c t i o n | 3

at an investment plan. It can go haywire in the short term due to disturbances in the market and imperfections in market on the basis of news and other criteria. However, in the long term, the theory advocated by many pundits in this field is that the price will move towards its value. Buffett had held on to his stocks for a considerably long time to realize the value and profits—if the fundamentals of the company are improving over a period of time it is better to hold on to the stock rather than selling them. It all depends on the staying power of the investor and also his objective while setting up the investment plan.

For example, different investors may have different objectives, like:

1. I want to generate supplementary income in addition to my professional/business income.

2. I want a quick buck and get out as soon as possible with quick gains.

3. I want value-based investment for long term; say a period of 10 to 30 years.

Let us understand what is value-based investment and its approach to investing conceptually.

VALUE INVESTMENT PHILOSOPHY

Wikipedia gives the definition of value investing as an investment paradigm that derives from the ideas on investment and speculation that Ben Graham and David Dodd began teaching at Columbia Business School in 1928 and subsequently developed in their 1934 text, Security Analysis. Although value investing has taken many forms since its inception, it generally involves buying securities whose shares appear underpriced by some form(s) of fundamental analysis. Such securities may be stocks in public companies that trade at discounts to book value or tangible book value, have high dividend yields, have low price-to-earning multiples or have low price-to-book ratios (definitions of these ratios are given subsequently for the understanding of


the reader). Investments based on these principles have stood the test of time over the past 80 years and therefore nothing can be deceitful with this approach. However, one needs to develop a judgment as to which company’s share price is at a discount and if there is a margin of safety (which can be defined as ratio of intrinsic value to market price of share). If the margin of safety is more than 1, then one can safely invest in the stock, provided there is no adverse trend developing in the stock.

As mentioned above, value investing is a technique pioneered by Benjamin Graham and perfected and practiced successfully by Warren Buffett. This approach requires that you must master the self discipline to avoid the advice of stock brokers, agents and the plethora of middlemen who promise sky-high returns and such. In addition, you must have a working knowledge of accounts to read the financial statements of companies so that you can interpret them correctly and identify positive and negative points of a company. Just remember you are investing not in the company but in its business and its prospects. Moreover, you should avoid going with the crowd in the stock market so that your analysis and foresight on the business of the company can fetch you gains and you should have the discipline and the wherewithal to avoid shuffling the portfolio at the drop of a hat. These are the basic conditions you must master if you want to be a value investor. Many studies have proven that value investing scores over even the growth investing style and other new fads that have come into the market. Some of the advices given by Buffett in the great book, How Buffett Does It: 24 Simple Investing Strategies from the World’s Greatest Value Investor by James Pardoe are summarized here for those who want to practice value investing:

Be patient and invest for the long term for a period of more than 10 years.

If you have found a great business, stay with it till you reap the rewards and do not exit from the stock on the basis of day-to-day price movements and other short-term trends developing out of the stock. Keep reading a lot about the business and keep adding on to more quantity


if the price comes down below the value due to market imperfections.

Keep the big picture in mind, do not be swayed by short-term adverse developments and avoid losing confidence in the stock. For example, it is often quoted that Buffett had turned an investment of $10 million into a $1 billion investment by holding on to these shares for life. He did not lose his cool and did not get out of the stock when the stock plummeted by 50 percent within 2 years of his initial purchase. The underlying logic of Buffett was that it was not a volatile business, so he held on and was rewarded for his judgment in collecting an annual dividend check of $10 million every year, which was his initial investment into the company.

Business analysis and performance is the key to investment. It is always good to study the long-term track record of the company. One should learn to buy into those companies whose business one can understand—this is the thumb rule that one should use.

It is a well known fact that Buffett did not buy into any of the fancy technology stocks when there was so much clamor for them in the Internet boom era. Buffett did not buy into them as he did not understand their business model. For example, companies like Coca Cola are investment worthy as they have predictable cash flows and are stable companies that will exist even 50 years from now.

Earnings and cash flows are two foundation stones based on which a company can build its safe future. Look for companies that have sustainable competitive advan tage. Here it is advantageous to determine those companies that stand out from their competitors. Remember, though Buffett bought into Berkshire Hathway in 1965, textile operations of the company had to be closed down 20 years later as it was not making money. Similarly, Buffett bought into PetroChina as it was the fourth most profitable oil company in the world and had an assured market in China. After a company is identified, one needs to wait for its price to become attractive.


It should be borne in mind that businesses wherein change is ubiquitous should be avoided as any technological innova-tion is likely to make these investments obsolete. Using this criterion it is always preferable to invest in old economy stocks as these are more sustainable.

Once you are convinced of a company to invest in using this approach, then do not spread your risks by investing less in the company. Focus your attention by putting your big money into that league. The distinguishing style of Buffett is the concentration of portfolio rather than the usual theory of diversification of stocks as practiced by many in the world. For example, Buffett took huge positions in the following companies after his analysis and they are worth billions now: (a) Coca Cola: 200 million shares, (b) American Express: 151 million shares, and (c) PetroChina: 2 billion shares. What is demonstrated by Buffett is that concentration of port folio rather than diversification is the essence of the game. For example, Berkshire Hathaway, in 2004, had investments only in 10 companies; at times it had invested only in 5 companies. Therefore, buying into the companies with the right businesses and the right price is the essence of value investments as practiced by Buffett.

If the company you invested in and its business are strong, it will automatically reflect in the operating results and the market price will adjust accordingly in the long term. If your goal is the long-term success of your investments, avoid looking at the prices daily and subjecting yourself to emotions that can make you take a wrong decision. Remember that the stock market is much more than you and your company and reflects the collective opinion and prospects of the company. Remember the popular words of Benjamin Graham who said, ‘Markets in the short run is a voting machine and in long run it is like a weighing machine.’ If you want to invest like Buffett, practice performance analysis for the company like him and innovate. This book is about new criteria for investments


that have been developed out of fundamental concepts that have been practiced for long and thus prescribes a unique approach to value investing.

Successful investments of Buffett were made during the market downturns when the usual investor gets out of the falling market by typically cutting his losses. For example, Buffett bought into Washington post at $6 a share when the marked was down in 1973 and more than 30 years later the share reached a price of $900, the second most expensive share in the New York Stock Exchange (NYSE). It is important that one does not run out of cash, particularly during periods of market crisis and should have adequate resources like Buffett to buy into the stock at the bottom of the market.

Even the great Buffett had his share of misjudgments as admitted by him in the case of Walmart. He admitted that he did not like the share price and missed the opportunity which could have earned him $10 billion later on.

It is crucial that one develops a judgment about the market and companies and their fundamentals so that one who is keen to invest is ready to exercise his/her judgment and reap the rewards later on.

HOW THE STOCK MARKET WORKS IN THE LONG RUN

A study by Barclays bank reproduced from the book, How the Stock Market Works: A Beginners Guide to Investment by Micheal Becket is given next to reinforce Buffett’s observations. Tables 1.1 and 1.2 show how various types of securities have appreciated if one has invested £100 in 1945 and 1990. This gives an indication of how different classes of securities behave and whether they can beat the inflationary trends in economy and give you real appreciation of your money.


Table 1.1 Value of UK Sterling Pound 100 Invested in 1945, Gross Income Reinvested

Type of Security Nominal Terms Real TermsEquity 97,023 4,132Gilts 3,296 140Cash 4,165 177

Source Barclays Capital Gilt Study, 2001

Table 1.2 Value of UK Sterling Pound 100 Invested in 1990, Gross Income Reinvested

Type of Security Nominal Terms Real TermsEquity 405 306Gilts 324 245Index-linked gilts 242 182Treasury bills 200 151Corporate bonds 361 272

Source Barclays Capital Gilt Study, 2001

It can be clearly seen that Warren Buffett’s observation to invest long term in equities is upheld by this study by Barclays over a period of last 50 years. As can be seen, equity as a class of security has outperformed both in nominal and real terms over other types of securities available in the market.

Temperament Required in the Stock Market

A person with a good temperament and an average intelligence can do better in the stock market than a brilliant person with a bad temperament and emotional attachment. This is a must to qualify for investing as stocks fluctuate greatly and require a sober mentality and cool calculatedness. It should be remembered that stocks rarely move up in a straight line and one should learn to invest in the underlying business of the company irrespective of short-term fluctuations in the stock of that company. One should learn to discipline his/her behavior in the stock market while investing and stick by those principles and adapt to circumstances like Buffett has in the market over a period of time.


What this Book Covers and its Learning Objectives

The book teaches different ways of identifying and picking stocks that have the potential for better returns using the intricacies of investment strategies and forming a judgment about how valuation ratios can be used in a better way and about what is good to invest and what is good not to invest by applying the concepts from first principles. The book has a limitation in that it does not teach methods of portfolio analysis, risk minimization, and so on, once the stocks are identified. That is another topic of relevance and is beyond the scope and purview of this book. The book covers ample and different techniques of identifying stocks for possible returns and also has formulas meant to determine when they can be sold to book profits accordingly.

MOST COMMONLY USED TERMS EXPLAINED

Before defining the most important terms commonly used in stock markets, it is ideal to understand what the Profit and Loss statement, Balance Sheet, and Cash Flow Statement of a typical company consist of. Every reader should understand and interpret these statements correctly and learn to use them wisely. It is a skill one has to master over years as there are many intricate financial techniques that are used to sugarcoat the annual reports of a company. One has to learn to understand the implications of these techniques.

A typical Profit and Loss (P&L) statement would consist of the following elements (Table 1.3):

Table 1.3 Profit and loss Statement of XYZ Company for the Year ended March 2009

Item Rs in CroresIncomeExpenditureEBIDTDepreciationEBIT

(Table 1.3 contd )


InterestOther IncomePBTTaxPATFace Value of ShareEPSMargins %EBIDTEBITNPM

EBIDT is earnings before interest, depreciation and taxes; EBIT is earnings before interest and taxes; PBT means profit before taxes. PAT means profit after taxes. EPS is earnings per share. Expenditure is the aggregate of all expenses incurred by the company, consisting of raw materials, manufacturing expenses, selling overheads, research and development (R&D) expenses, and so on, which are typically incurred to run the day-to-day operations of the company.

One of the important things to see is how much profit the company is making on its operations and also monitor other income as a percent of sales so that one knows the basic profitability of its core businesses. It is also important that the company maintains a healthy net profit margin (NPM) ratio.

Now, after studying the P&L statement of a company, let us take a look at a typical balance sheet of a company and what it would consist of (Table 1.4):

Table 1.4 balance Sheet of XYZ Company as on 31 March 2009

Item Rs in CroresShare CapitalReservesTotal Shareholder FundsSecured Loans

(Table 1.4 contd )


Unsecured LoansTotal DebtTotal LiabilitiesGross BlockLess Accumulated DepreciationNet BlockCapital WIPInventoriesSundry DebtorsCash and BankLoans and AdvancesTotal Current Assets (A)Total Current Liabilities (B)Net Current Assets (A − B)Miscellaneous Assets Not Written OffNet Deferred TaxTotal Assets

The balance sheet lists down the assets and liabilities as on a particular date, whereas the P&L statement is for a period and reflects the transactions carried out during that period.

The most important thing to look for in the balance sheet is the debt to equity ratio. Debt carried out beyond reasonable limits can cause problems for the company and the company may go bankrupt, and so on. A reasonable debt–equity ratio for a typical company is 2. Some industries by their very nature require a higher debt–equity ratio (shipping, cement, and so on). Net current assets reflect the working capital amount, which is nothing but excess of current assets over current liabilities and is used to run the day-to-day operations of the company.

Another statement that is important is the cash flow statement, which is a tool to analyze whether the company is generating operating cash flows, and if so, at what level, and so on. This is an important parameter to measure how cash is generated by the company (see Table 1.5).


Table 1.5 Cash Flow Statement

PAT aDepreciation bChange in NWC cOperating Cash Flow d = a + b + cCapex Investment Cash Flow eLoans Raised fCapital Issue gDividend hFinancial Cash Flow i = f + g − hOpening Cash jClosing Cash k = j + i + d + e

One caution that the reader is advised is that some companies generate cash easily and some companies are hard-pressed due to capital expenditure to be carried out periodically to keep assets in good condition. Thus, one needs to exercise caution in companies that have greater capital spending. Greater the capital spending, the more one needs to utilize this investment carefully and deploy those assets strategically to yield profits—this is the technique that pays off well. Therefore, one needs to evaluate free cash flows of the company (which is nothing but operational cash flow minus capital expenditure), which is a good indicator of the health of the company.

Some of the most popular ratios used in stock market analysis are presented in a structured fashion here (Table 1.6). The most popularly used figures are return on equity (ROE) and return on capital employed (ROCE). These two determine how a typical company rewards its shareholders and adds value to the shareholders. Enterprise value (EV) to sales is a valuation ratio to measure how the company fares over a period of time. Ratio analysis is a quantitative analysis of information contained in financial statements of a company. This analysis is used to compare how a company is performing over a period of time or in relation to its competitors.


Table 1.6 Ratio analysis

RatiosEBITDA Margin %EBIT Margin %Net Profit Margin %Asset Turnover = Sales/AssetsROE %ROCE %Debt to Equity RatioCurrent RatioEV/SalesEV/EBITDAP/EP/BVBook Value

The quality of management is an important distinguishing factor between good performance and average performance in the stock market. One needs to evaluate the quality of management by asking the following questions:

Is the management working for shareholders’ interest or not? Is the management frugal or extravagant? Does the annual report truly disclose all relevant information

about the business affairs of the company?

The famous Satyam Computers case can reopen the eyes of the investors in analyzing about the management of any company by asking these questions and finding their answers.

Now, since we have a general idea of the stock market and its various related issues, one can define the terms commonly used in stock markets to understand them.

Dividend Yield

One of the basic terms used often is dividend yield of a share. Dividend yield is defined as the return that the investor gets if


he buys into the company at the market price prevalent on that day by calculating the ratio of latest dividend declared by the company per share to the market price prevalent on the day of buying. Therefore, it can be defined as:

Dividend yield = Dividend per share/market price of the share

For the companies being traded in the stock market these days this figure can vary between 0 and 10 percent in the normal range, and more in extreme cases. Generally, this is a conservative return that one gets if one is eligible for dividend. In addition, one can look at share price appreciation as a possible return. One should learn to evaluate a company’s share price as to whether it is high or low depending on the dividend yield. If it is low, then the price may not be attractive as the company is not declaring adequate returns in terms of dividend and may be conserving profits for a growth-oriented approach, and so on. There can be many ways in which a company can try to enhance value to its shareholders, but they do not come under the purview of this book.

Dividend Payout

Dividend payout is defined as ratio of dividend per share to earnings per share of the company. In short, this measures how much percent of profits is being distributed as dividend by the company. This declares the company’s approach to reward the shareholders. It could be liberal or it could be conservative. This ratio can vary from 0 to more than 100 percent depending on the policy of the company. However, it should be remembered that if it is more than 100 percent, then the company is declaring dividend from past years’ profits as well.

Earnings Per Share

Earnings per share (EPS) is defined as ratio of net profit to the number of shares issued by the company.


Price to Earnings Ratio

Another term most commonly used in share markets is price to earnings ratio, or in short, P/E ratio. This ratio is nothing but the ratio of market price to earnings per share of the company. Most of the financial dailies give this statistic in the share quotes papers. P/E ratio can be based on different earnings per shares, namely trailing 12-month basis, historic basis, or futuristic scenario. Therefore, one needs to verify which earnings per share is being talked about when the P/E ratio is mentioned as a yardstick for investment in the shares of a company.

Market Capital izat ion (MCAP) to Sales

Another important valuation ratio that is discussed and needs to be introduced in this book is the ratio of market capitalization (MCAP) to sales, short form of which is MCAP/Sales.

In general, market capitalization refers to the market value of the shares of the traded company. This fluctuates daily for the company depending on trends in the market. This fluctuation creates an opportunity to invest in the company when they are bought at low prices and sold at high prices later on for profit. This is not so simple in the market, as what is low and what is high is relative in market language and one needs to develop a sharp eye and a knack to judge. In short, the ratio of MCAP to sales is a barometer of valuation of markets in aggregate, as a whole, and also for individual companies. In general, the cut-off point to analyze companies based on this yardstick is whether this ratio is less than one or greater than one. The criteria suggested later on in the book fine-tunes the investment using this ratio.

MCAP/Assets

Another ratio that is used to assess a company’s worth is the ratio of market capitalization to value of assets deployed in the company. Therefore, MCAP/Assets throws light on whether the


market is valuing the company at less than its assets or more than its assets. It all depends on how efficiently the company deploys its assets and creates profits. The cut-off point again is one and the explanation for MCAP/Sales holds good for MCAP/Assets too.

Capital Employed

Capital employed in business is nothing but its net worth and long-term borrowings. Net worth is defined as the sum of capital and reserves (accumulated profits) of the company. Long-term borrowings are nothing but the debt that is borrowed for long-term purpose and needs to be deployed in business carefully as it bears interest cost.

Return on Capital Employed

Return on capital employed (ROCE) is nothing but an effi-ciency measure. It is the ratio of net profit of the company to capital employed in business. The higher the ratio the better the company’s performance, as it reveals that the company is leveraging its capital in an optimum manner and is thus on a high profit trajectory. This figure varies from year to year depending on the profitability of the company. Thus, one needs to identify companies that have this ratio growing in a steady manner and ignore temporary boosts in profitability due to the impact of market forces.

Many books have been written on this topic that have added to the thought processes of investors across the globe. This book is an attempt to bring clarity to the thought process and lay down an approach that is purely through data analysis, wherein the insight gained by analysis is used for taking investment decisions. This analysis has been performed successfully by the author and has fetched handsome returns during the past 4–5 years, even though the market was in bull phase and volatile. The author has confidence that the approaches suggested in this book are value-


based investment approaches derived from the fundamentals and will work in any type of market. It is to be noted that the approaches suggested are not for trading in stocks and the investor has to wait patiently for these approaches to yield positive returns. This book advises only on fundamentals in analysis and does not recommend any trading techniques. Therefore, stop-loss criteria is not applicable for all the approaches suggested in this book. Investors have to continuously monitor market conditions and the stocks they have invested in to verify whether the fundamentals of the company are in good shape or not; if they have deteriorated, then exiting the stock is the best option. Therefore, investors are advised to monitor their investments carefully and periodically and revisit the assumptions of these approaches at periodic intervals.

This book is for a reader who is already doing investments haphazardly and prescribes a data analysis methodology wherein the investor can gain handsomely. The investor is advised to keep copies of Business Standard newspaper and Capital Market fortnightly magazine, which are readily available in the market, so that the reader can identify where to look for the relevant information for working out further the ideas in this book. The published data about the companies in Capital Market fortnightly magazine and also Business Standard financial daily can be utilized to a great extent and supplementary income can be generated for sincere investors who follow this approach. This is the entire objective of the book. The author strongly advocates systematic analysis of factors and data so that investment can become a science. While this approach is not foolproof and is subject to the vagaries of the stock market, it will enable the investor to remain fully armed when the situation is right so that he can move in like Warren Buffett and track stocks and keep adding when the value is attractive for any specific stock. The investor can make use of information available in the following sources:

Capital Market (fortnightly magazine) Business Standard (daily) Business Line (Sunday edition)


The first question that an investor should ask is: “What should be the P/E ratio of the company and is it attractive to buy?” The following formula helps one identify companies worthy of investment and accurately predict what should be the theoretical price to earnings ratio for any company.

Dividend payout/dividend yield of any company is equal to the theoretical price to earnings ratio.

Dividend payout/dividend yield

= dividend per share earnings per share/

dividend per share market price/ … (1)

= theoretical price to earnings ratio

assumptions and conditions under which this formula can be applied

The P/E ratio is a dynamic variable and depends on market conditions, which fluctuate greatly. However, informed investors who observe the market closely find gaps when a particular scrip is a value buy, and so on, depending on the variations of this ratio. The above formula can be applied to any company that regularly declares dividend. The formula can be applied only if the dividend and EPS are likely to be sustained in future years at the same levels as that of the current year. In essence, the formula should not be applied when earnings and dividends are likely to decrease in future years. Therefore, the holding period for review of decisions made on this formula is one year and needs to be reviewed when the next quarterly results are announced as to whether the EPS is maintained at the same level or not. Otherwise, the investor has to book his profits and exit from the scrip as indicated by this formula if the conditions are not fulfilled. It is immaterial if the market is in a bull phase or bear phase, or sideways (that is, when the market is neither going up or down, but in a steady state or consolidating, etc.). The only thing to remember is that the return is faster or slower depending on the market conditions, and so on, and the waiting period for the profits depends exactly on the market conditions. However, one needs to be watchful of the environment of the company


in which investments are made when using this formula. For instance, say it is a sugar company or an oil company and the price of sugar or oil is falling, then investments based on this formula can lead to erroneous results though the formula may recommend based on current year’s profitability.

The simple equation (1) analyzes what should be the price to earnings ratio of the firm, which comes very handy for investors. It also identifies value buys when the model predicts a high theoretical P/E ratio and the actual P/E ratio (based on trailing 12 months’ EPS) is small. The real reason why these two ratios differ is the basis of calculation. The actual P/E ratio is calculated using the trailing 12 months’ EPS (which is the latest possible EPS available and given in Business Standard newspaper), whereas, the theoretical P/E ratio indicated by the above formula considers the historic and just-concluded financial year’s EPS. If the trailing 12 months’ EPS is more than the historic EPS, it gives an opportunity for the price to go up and that is the reason why this formula holds true in investment approach of value buying and predicts correctly despite the market uncertainty, vagaries, and so on. Then the next question that comes to mind is what should be the holding period for buys based on this decision. There can be no answer to this question as the investment horizon indicated by this formula is maximum one year and the formula needs to be applied particularly in view of new evidence in terms of latest dividends and EPS announced by the company; accordingly, the same needs to be updated every year based on the formula. The formula predicts that the company’s P/E ratio should get adjusted to the figure indicated in equation (1) over a period of time. The author has time and again verified that the target price given by this formula for a specific company closely reflects the target figures reported using complicated discounted cash flow models worked out by reputed equity research firms (Kotak Securities, for instance, has been verified by the author personally). Thus, the formula gives an opportunity to invest in a particular scrip. Application of this principle can be illustrated through worked out examples from the data published in Business Standard dated 24 November 2005 (all Thursday editions of this


paper contain the relevant data for top 200 traded companies of the previous day). In Table 1.7, the data for the first three columns is from the actual P/E ratio to dividend yield taken from this newspaper. Upside potential indicated in the last column is a calculated figure—the ratio of theoretical P/E ratio to actual P/E ratio. This table calculates the gain the investor would make if he/she invests in the particular scrip with its actual P/E ratio and holds on to the stock till its actual P/E ratio becomes equivalent to the theoretical P/E ratio. The experience of the author shows that stock market invariably discovers the value and accordingly the P/E ratio adjusts over a period of time.

Table 1.7 Data analysis for Various Companies as per Dividend Yield Model

CompanyActual P/E

Ratio

Div Payout

Div Yield

Theoreti cal P/E ratio

Upside Potential in Percen tage

Tata Steel 5.31 37.25 1.17 31.83761 499.57Mphasis BFL 16.99 63.25 1.64 38.56707 126.99Zee 19.87 23.42 0.66 35.48485 78.58Kotak Mahindra 33.34 14.23 0.24 59.29167 77.83Bajaj Hindustan 19.01 4.37 0.16 27.3125 43.67BPCL 6.12 24.01 2.96 8.111486 32.54Amtek Auto 26.6 8.9 0.26 34.23077 28.68Ballarpur 9.68 22.85 1.85 12.35135 27.59Sun Pharma 28.27 20.55 0.58 35.43103 25.33Syndicate Bank 7.85 24.23 2.52 9.615079 22.48Hexaware 17.36 20.2 0.98 20.61224 18.73Siemens 42.46 17.12 0.34 50.35294 18.58ABB 40.87 16.99 0.37 45.91892 12.35Wockhardt 17.63 24.13 1.22 19.77869 12.18SBI 8.43 13.01 1.39 9.359712 11.02Nagarjuna Constructions

25.4 14 0.5 28 10.23

Canara Bank 6.29 18.15 2.69 6.747212 7.26Balrampur Chini 11.62 22.85 1.85 12.35135 6.29ONGC 10.15 42.17 3.92 10.75765 5.98UTI Bank 16.51 21.09 1.21 17.42975 5.57

(Table 1.7 contd )


Tata Chemicals 11.03 29.24 2.52 11.60317 5.19Larsen & Toubro 18.76 33.09 1.7 19.46471 3.75Aftek 13.21 8.05 0.59 13.64407 3.28TCS 32.55 25.55 0.76 33.61842 3.28Iflex Solutions 31.82 16.72 0.51 32.78431 3.03BHEL 26.67 16.7 0.61 27.37705 2.65Bombay Dyeing 27.36 33.59 1.22 27.53279 0.63Cipla 25.51 22.59 0.89 25.38202 –0.50Bank of Baroda 9.23 22.01 2.41 9.13278 –1.05HCL Info 29.3 74.11 2.56 28.94922 –1.19M&M 14.55 21.65 1.51 14.33775 –1.45Gujarat Alkalies 4.64 4.98 1.09 4.568807 –1.53Bank of India 12.68 25.22 2.02 12.48515 –1.53Sesa Goa 8.03 18.15 2.31 7.857143 –2.15Allahabad Bank 6.32 20.73 3.38 6.133136 –2.95Hero Honda 19.37 44.38 2.37 18.72574 –3.32Wipro 37.69 20.93 0.58 36.08621 –4.25BEML 16.47 18.89 1.2 15.74167 –4.42Dabur India 30.63 43.36 1.49 29.10067 –4.99Bharat Forge 37.87 25.2 0.71 35.49296 –6.27HDFC Bank 28.43 17.3 0.65 26.61538 –6.38Hindustan Unilever

30.95 83.37 2.91 28.64948 –7.43

Mcdowell 60.05 24.41 0.44 55.47727 –7.613i Infotech 21.38 15.6 0.79 19.74684 –7.63PNB 9.23 10.93 1.29 8.472868 –8.20HDFC 27.47 40.13 1.61 24.92547 –9.26Andhra Bank 6.86 20.69 3.36 6.157738 –10.23ITC 14.43 30.88 2.39 12.9205 –10.46IVRCL 26.93 9.73 0.41 23.73171 –11.87Ashok Leyland 10.95 31.25 3.24 9.645062 –11.91Infosys 39.52 14.56 0.42 34.66667 –12.28SAIL 2.98 17.16 6.59 2.603945 –12.61ND TV 28.33 11.62 0.47 24.7234 –12.73IPCL 5.1 8.65 1.96 4.413265 –13.46Adlabs 48.57 27.55 0.66 41.74242 –14.05Voltas 31.01 27.16 1.02 26.62745 –14.13

(Table 1.7 contd )


JSW Steel 3.23 9.4 3.42 2.748538 –14.90Indian Oil 9.78 24.32 2.93 8.300341 –15.12Glaxo Pharma 29.95 59.78 2.36 25.33051 –15.42Bajaj Auto 26.07 26.57 1.21 21.95868 –15.77Gateway 57.23 36.35 0.76 47.82895 –16.42HCL Technologies

49.17 127.24 3.11 40.91318 –16.79

GAIL 9 23.32 3.12 7.474359 –16.95Colgate 31.9 70.18 2.65 26.48302 –16.98Satyam 29.24 18.69 0.77 24.27273 –16.98Tata Motors 15.25 26.8 2.18 12.29358 –19.38Patni Computers 25.06 9.01 0.45 20.02222 –20.10NTPC 13.82 25.48 2.33 10.93562 –20.87GE Shipping 5.01 15.55 4.01 3.877805 –22.59GNFC 5.6 17.65 4.08 4.32598 –22.75SCI 3.38 11.51 4.41 2.609977 –22.78Cummins 22.5 45.79 2.64 17.3447 –22.91NALCO 9.49 15.2 2.1 7.238095 –23.72Union bank 8.63 20.32 3.11 6.533762 –24.29Oriental 9.84 6.77 0.92 7.358696 –25.21Rolta 10.72 15.03 1.89 7.952381 –25.81Matrix 25.58 12.14 0.64 18.96875 –25.84Grasim 13.95 12.53 1.22 10.27049 –26.37Indian Hotels 35.2 30.9 1.2 25.75 –26.84HPCL 7.74 26.3 4.65 5.655914 –26.92Titan Industries 79.77 18.02 0.31 58.12903 –27.12ICICI Bank 21.12 24.39 1.62 15.05556 –28.71ACC 22.91 22.11 1.36 16.25735 –29.03VSNL 13.47 17.09 1.79 9.547486 –29.12Reliance Energy 18.3 10.08 0.79 12.75949 –30.27Hindalco 11.81 10.35 1.28 8.085938 –31.53Gujarat Ambuja Cements

24.02 28.5 1.74 16.37931 –31.80

Maruti 19.63 4.41 0.33 13.36364 –31.92Reliance Industries

15.21 9.25 0.9 10.27778 –32.42

Tata Power 14.93 16.31 1.7 9.594118 –35.73Polaris 20.93 18.68 1.41 13.24823 –36.70

(Table 1.7 contd )


GTL 7.66 7.3 1.52 4.802632 –37.30Jindal Stainless 5.71 7 2 3.5 –38.70Jaiprakash 27.86 12.41 0.74 16.77027 –39.80MTNL 8.78 18.45 3.73 4.946381 –43.66Visual Soft 15.17 10.51 1.27 8.275591 –45.44Century Textiles 20.91 9.41 0.87 10.81609 –48.27Arvind Mills 19.25 7.07 0.86 8.22093 –57.29GHCL 31.97 25 1.98 12.62626 –60.50CESC 11.35 4.24 0.97 4.371134 –61.48Ranbaxy 66.25 53.69 2.32 23.14224 –65.06Gammon 113.41 4.87 0.13 37.46154 –66.96Reliance Cap 243.01 27.48 0.41 67.02439 –72.41Orchid 47.62 14.69 1.25 11.752 –75.32Dr Reddys 222.29 24.23 0.54 44.87037 –79.81

Source Business Standard, 24 November 2005 (for columns 1–3).

The model clearly shows that Tata Steel, Mphasis BFL, Kotak Mahindra, Bajaj Hindustan, and so on, had good potential to go up as on that date. One can decide and invest in these stocks based on other risk considerations and actual status of the market by looking at other parameters (like sugar prices falling for instance in case of Bajaj Hindustan) and then take a decision on which scrip to invest. The model has clearly shown in actual practice to be helpful in identifying companies whose P/E ratio is not reflected correctly in the market. Most of the time the decisions using the above approach have benefited the author considerably. The author has found that in practice this simple model predicts correctly the same target price recommended by reputed research firms using complicated discounted cash flow models. This model is simple in approach and offers definite clarity and comes handy for analysis. The only shortcoming of this approach is that this calculation does not predict what would be the returns in a short span of time. One has to wait till the market recognizes the particular scrip, and sufficient time is given for adjustment of P/E ratio to theoretical parameters. In a bull market the returns will be faster and in a bear market the returns would be slower as the market has to discount negative news and recognize the value in the stock.


One aspect that has to be mentioned is that whenever the upside potential is indicated as negative for some companies, it only reinforces the observations that current dividend payout policy of the company does not justify the actual P/E ratio and that the price may have been arrived at based on the earnings growth rate projected, expectations of new products, takeover, acquisitions, or some other good news factored in, and so on. Any other inference can be misleading since P/E ratio discounted by market may be considering the growth rate of the company and other factors and hence, the actual P/E ratio can become more than the theoretical P/E ratio, as is the case in most of the firms in the Table 1.7.

One can decide whether to wait till the actual P/E ratio equals the theoretical P/E ratio. But the author suggests that one can book profit at an appropriate time as markets are uncertain. One should partially book profits once this approach yields positive results as the objective is to generate a supplementary income to the investor, which means booking a profit after a reasonable rise in price as per market conditions.

Results are once again verified in the latest possible way to show that this method works even in bear market, which was the case in 2008 (Table 1.8).

Table 1.8 Movement of P/e Ratios of Stocks Identified

CompanyActual P/E ratio as on

24/11/2005

P/E ratio as on 2/7/2007

Theoretical P/E ratio

indicated by the firm

P/E ratio as on 6/8/2008

Tata Steel 5.31 8.68 31.83761 6.14Mphasis BFL 16.99 47.21 38.56707 16.77Kotak Bank 33.34 41.27 59.29167 63.24Bajaj Hindustan 19.01 12.73 27.3125 31.32

Source Business Standard, 6 August 2008.

It can be seen that Tata Steel and Mphasis BFL have appreciated considerably and Bajaj Hindustan has corrected due to correction in sugar scrips. Therefore, considering the experience of Bajaj


Hindustan, it is preferable for investors to keep booking the profit periodically after there is an appreciation of 15 percent. If the individual has staying power in the market then he can wait till the actual P/E ratio equals the theoretical P/E ratio.

2Valuation Ratios Related to

Market Capitalization

W hile there is no doubt that there are many parameters to judge whether valuations are right or wrong, the ratio of market

capitalization to sales is one ratio that gives a beautiful insight into the working of the various parameters. Other parameters to consider are the following:

Price to earnings ratio, which is the ratio of market capitalization to net profit.

Price to book value, which is the ratio of market capitalization to net worth.

Dividend yield. Enterprise value to EBIDT. Market capitalization to operating profit. Market capitalization to sales.

FIRST MODEL

Here we will discuss the intricacies and making use of market capitalization to sales ratio in an innovative way.

Market capitalization/sales = number of shares × market price/sales

V a l u a t i o n R a t i o s R e l a t e d t o M a r k e t C a p i t a l i z a t i o n | 27

Using this formula and dividing and multiplying by net profit will result in the following:

number of shares × market price net profitMCAP= ×

Sales sales net profit

net profit market price= ×

sales earnings per share

P= net profit margin × ratio

E ...(2)

While formula (2) is simple and taught to many students and listed in many books on finance and investment management, the application of this formula to stock market investing is on the lower side. While it requires judgment to say whether the MCAP/Sales ratio is attractive or not, what is not correctly seen is that this model can pick out winners from the basic principles.

Using the aforementioned model, the following scenarios arise for analysis (Table 2.1).

Table 2.1 analysis of Scenarios of MCaP/Sales Ratios

MCAP/SalesNet Profit Margin

P/E Ratio Action Proposed

High High High

Risky for investment. Opportunity for value appreciation may be limited.

Value needs to be judged. High Low

Attractive for investment and hence less risky. There may be more value in these stocks and it needs to be harnessed.

Value needs to be judged. Low High Risky for investment.

Low Low LowNot so attractive for investment.

Source Author.


Using the above formula, one can say that I will not invest in any company that has a net profit margin of less than bank savings rate and then I will develop a strategy to analyze the stocks that give attractive returns. While practicing this formula, it is seen that MNCs and FMCGs have very high MCAP/Sales ratios and they have to be valuated accordingly. It is a relative valuation, based on either sector average net profit margin or P/E ratio as given in capital market publications; comparing the competing companies in the same sector would reveal opportunities for investment. How do we use the aforementioned formulae to our advantage? Thus as shown in Formula 2:

MCAP P= NPM × ratio

Sales E ...(3)

Table 2.2 analyzes the range of ratio of MCAP/Sales in the market for different companies and how segmentation of the same can be done to arrive at investment decisions.

Table 2.2 basis for Investment logic Using MCaP/Sales Ratio

MCAP/Sales

Explanation Conditions under which to Exit

< 1.0 One needs to identify companies, which have high net profit margin (NPM) and less P/E ratio and invest in them.

Investment decisions based on this criteria have to be looked at along with market sentiments. In addition the company invested in should not have a drop in its NPM when the next financial results are out (there should not be a drop in NPM even in quarterly results). Then you can hold on and continue to wait as long as the company’s P/E ratio is less than its competitors but the NPM is more and its performance does not deteriorate. These are small to mid cap companies and value needs to be harnessed in them by using this formula.

(Table 2.2 contd )


> 1.0 to < 2.0

High performing companies have this range. One needs to identify companies that have high NPM and less P/E ratio and invest in them.

This is a reasonable range for any company’s MCAP/Sales to fall within, and it is not overpriced. However, one needs to frequently crosscheck market conditions for the company so that it does not get overvalued.

> 2.0 Only high growth prospect companies, MNCs and FMCGs are discounted with this high value. Here also, one needs to identify companies that have high NPM and less P/E ratio and invest in them.

Investments in these companies are more risky than the above two categories of companies and one has to be careful about investing in these companies. However, most of the companies that have this range are MNCs and FMCGs and they have better brand images. Drastic fall in the prices of stocks of these companies may not happen as compared to the first type of companies, which invariably are small cap and mid cap companies. Most of the companies in this range are reputed large cap companies, which offer reasonable returns but not extraordinary returns.

Source Author.

How Does One Decide When to Exit The Stock Using This Model?

If you feel that MCAP/Sales has grown faster for the company than the market as a whole or in aggregate, then you should book profits. MCAP/Sales ratio is also a good indicator of overheatedness in the market and whether it is overvalued. One should learn to see if MCAP is growing at a faster rate than sales of the companies or profitability of companies is coming down, and so on. Then it is better to exit the stock irrespective of the market conditions, whether bull or bear. Not greed or wishful thinking but plain objective assessment of data indicated by the companies should be used for valuebased investment approach advocated in this book.


Assuming that we want to conservatively look at companies with MCAP/Sales ratio of less than one and find whether there exists value in them, then the companies which we want to identify can be looked in the following ways:

Identify companies with NPM 10 percent and companies with price to earnings (P/E) ratio of < 10.

One can identify companies which have high NPM and simultaneously have low P/E ratio.

This will ensure that one finds value in the buying using the above approach. Table 2.3 lists companies sorted out in descending order of MCAP/Sales ratio.

Table 2.3 Companies Sorted Out on the basis of MCaP/Sales

CompanySales

(in Rs crores)MCAP

(in Rs crores)MCAP/Sales

Infosys 9,521 120,312 12.64Bharti Airtel 11,664 109,403 9.38Suzlon Energy 3,841 35,449 9.23TCS 13,263 109,505 8.26Wipro 10,602 80,452 7.59NMDC 3,710 26,366 7.11Cipla 2,897 18,678 6.45ITC 10,317 65,280 6.33Satyam 4,792 28,957 6.04Gujarat Ambuja Cements 3,074 17,734 5.77ACC 3,318 18,220 5.49Container Corpn. 2,433 13,218 5.43Dr Reddys 2,355 12,521 5.32ABB 2,963 14,733 4.97Siemens 3,637 17,606 4.84Dabur India 1,722 8,096 4.70Indian Hotels 1,837 8,411 4.58BHEL 13,442 59,448 4.42Jaiprakash 3,273 14,313 4.37Hindustan Unilever 11,579 49,361 4.26

(Table 2.3 contd )


Neyveli Lignite 2,201 9,210 4.18NTPC 26,985 112,798 4.18HCL Tech. 4,571 19,054 4.17Nestle 2,475 10,063 4.07Reliance Energy 3,976 15,417 3.88Motor Industries 2,977 10,627 3.57United Phosphorous 1,668 5,636 3.38Pantaloon 1,867 5,912 3.17Bajaj Auto 8,161 25,584 3.13PCS 1,954 5,392 2.76Punj Lloyd 1,727 4,761 2.76Cummins 1,806 4,971 2.75NALCO 4,854 12,947 2.67ONGC 65,523 172,288 2.63Ranbaxy 5,157 13,404 2.60Lupin 1,685 4,377 2.60Bharat Electronics 3,653 9,306 2.55IVRCL 1,712 4,164 2.43Sesa Goa 1,907 4,596 2.41Jindal Steel & Power 2,564 6,140 2.39VSNL 4,562 10,881 2.39L&T 16,537 39,117 2.37Godrej Industries 2,034 4,791 2.36Bharat Forge 2,971 6,961 2.34Grasim 10,213 22,980 2.25Aditya Birla Nuovo 4,817 10,685 2.22Asian Paints 3,166 6,762 2.14Sterlite 13,102 27,890 2.13Nagarjuna Constructions 1,829 3,884 2.12Maruti 12,106 25,540 2.11Reliance 80,055 168,402 2.10Century Textiles 2,589 5,441 2.10M&M 9,807 18,766 1.91TATA Power 5,739 10,691 1.86HCC 2,024 3,560 1.76Hero Honda 8,713 14,478 1.66Voltas 1,954 3,243 1.66

(Table 2.3 contd )


BEML 2,056 3,397 1.65Hindalco 11,761 19,418 1.65Crompton 4,132 6,561 1.59Britannia 1,713 2,631 1.54Moser Baer 1,663 2,553 1.54Raymond 1,717 2,621 1.53GE Shipping 2,036 3,062 1.50MTNL 5,572 8,051 1.44Videocon 6,709 9,322 1.39TATA Motors 23,587 31,618 1.34Nirma 2,088 2,797 1.34GAIL 16,770 21,471 1.28TATA Chemicals 3,502 4,473 1.28TATA Steel 20,244 25,572 1.26TATA Tea 3,101 3,912 1.26SCI 3,531 4,392 1.24SAIL 28,346 34,220 1.21Ashok Leyland 5,329 5,179 0.97CESC 2,556 2,404 0.94Ballarpur 1,908 1,739 0.91Jet Airways 5,693 5,172 0.91JSW Steel 6,018 4,911 0.82Jindal Sawd 2,267 1,774 0.78Vardhman Text 1,949 1,489 0.76ITI 1,660 1,195 0.72DCM Shriram Consolidate 2,398 1,723 0.72

Apollo 2,613 1,687 0.65Welspun Gujarat Stahl 1,787 1,099 0.61RCF 3,044 1,864 0.61Jindal Stainless 3,131 1,869 0.60IPCL 10,864 6,475 0.60MRF 2,950 1,748 0.59MMTC 16,393 9,525 0.58Essar Steel 6,168 3,550 0.58GNFC 2,448 1,360 0.56Sundaram Clayton 4,112 2,181 0.53

(Table 2.3 contd )


Bhushan Steel 2,716 1,357 0.50GSFC 2,832 1,372 0.48Arvind Mills 2,125 1,006 0.47Chambal Fertilizers 3,084 1,438 0.47Adani 12,336 5,428 0.44EID Parry 2,892 1,183 0.41Usha Martin 1,796 706 0.39National Fertilizer 3,590 1,400 0.39Mukand 1,667 566 0.34Indo Rama Synthetics 1,912 626 0.33HCL Info 11,368 3,676 0.32CEAT 1,744 535 0.31IOCL 162,418 46,486 0.29Ispat Industries 4,914 1,295 0.26JK Industries 2,078 479 0.23PTC India 3,108 713 0.23Rajesh Exports 5,283 1,131 0.21Ruchi Soya 5,687 871 0.15BPCL 75,850 11,428 0.15Uttam Galva 1,788 239 0.13Zuari 3,585 456 0.13HPCL 75,143 8,763 0.12STC India 7,595 418 0.06National Steel 1,911 61 0.03Surana Corp. 1,693 45 0.03Vishal Exports 3,936 79 0.02

Source Data compiled from Capital Market, January 2007.

Table 2.3 lists down companies in descending order of MCAP/Sales ratio and serious investors can identify companies for further research by short listing the companies that have a MCAP/Sales ratio of less than 1 and in the range indicated in Table 2.1 and Table 2.2.

Table 2.4 analyzes the Equation (2) parameters and shows how to identify shares in the Nifty basket of companies for investment.


Table 2.4 NPM and P/e Ratio for Nifty basket of Companies

Company NPM P/E Ratio MCAP/SalesReliance Industries 0.1112 18.7 2.079ONGC 0.2919 12.5 3.648Bharti Airtel 0.178 42.3 7.52TCS 0.2414 34.7 8.37Infosys 0.2682 40.2 10.78ICICI Bank 0.1346 27.4 3.68Wipro 0.1954 34 6.64BHEL 0.1247 29.9 3.72ITC 0.2324 25.8 5.99SBI 0.1019 16.2 1.65SAIL 0.1415 7.4 1.04L&T 0.0586 40.6 2.37HLL 0.1197 32.2 3.85HDFC 0.2826 29.6 8.19Suzlon Energy 0.2167 37.5 8.12HDFC Bank 0.1529 32 4.89Tata Steel 0.2316 7.7 1.78Satyam Computers 0.2186 24.5 5.35Sterlite Industries 0.0689 34.3 2.36Tata Motors 0.068 20.6 1.40Bajaj Auto 0.1393 23.0 3.2GAIL 0.1413 10.4 1.469Maruti Udyog 0.0996 18.5 1.84Grasim 0.119 24.2 2.879HCL Tech 0.1856 28.9 5.36Sun Pharma 0.2676 34.6 9.25Cipla 0.2122 26.3 5.58Siemens 0.0798 34.2 2.72M&M 0.0858 24.1 2.06Ambuja Cement 0.2196 22.2 4.87Hindalco 0.1444 9.4 1.35ABB 0.074 50 3.7Nalco 0.3170 6.2 1.96

(Table 2.4 contd )


PNB 0.1295 10.2 1.32ACC 0.097 22.9 2.22Hero Honda 0.1028 16.5 1.69Ranbaxy 0.048 47 2.25Zee 0.083 213 17.67VSNL 0.1377 23.2 3.19Relaince Energy 0.1614 16.2 2.61Dr Reddys 0.092 31.8 2.92BPCL 0.0038 8.4 0.03Tata Power 0.1024 19.9 2.03Glaxo Pharma 0.2081 27.4 5.7IPCL 0.0988 7.1 0.70MTNL 0.105 17.4 1.827HPCL 0.00569 5.9 0.03Dabur 0.1393 37.4 4.97

Source Capital Market, 1–14 January 2007.

From Table 2.4 it can be seen that value lies in buying the following shares among the Nifty stocks as they have high NPM, low P/E and thus a reasonable MCAP/Sales Ratio.

SBI Tata Steel M & M Maruti Hero Honda IPCL

Converting the above table by grouping 10–12 companies into one category and projecting it as bubble chart, wherein the Xaxis is NPM and Yaxis is P/E ratio, helps to clearly know the implications of this model. The bubble size indicates the value of MCAP/Sales. This kind of graph can help us identify which companies are attractive to buy to invest. In Figure 2.1, the bubble size indicates the ratio of MCAP/Sales.


FIgURe 2.1 NPM vs P/e Ratio: Illustration 1

Source Created from the data in Table 2.4.

Figure 2.1 clearly illustrates that ONGC is a clear choice for investment as its P/E ratio is low but NPM is high.



Figure 2.2 clearly illustrates that Tata Steel is a clear choice for investment as its P/E ratio is low but NPM is high.


Figure 2.3 clearly illustrates that GAIL is a clear choice for investment as its P/E ratio is low but NPM is high.






Figure 2.4 clearly illustrates that Nalco is a clear choice for investment as its P/E ratio is low but NPM is high.

However, one can justify higher valuation of MCAP/Sales ratio if the growth rates of business are high for that company and accordingly decisions have to be taken. One can also compare the competing companies in the same sector and arrive at conclusions as to where to put your money based on this parameter. For example, using data from Table 2.4, we can create Table 2.5, which shows a summary about how competing companies are faring in terms of NPM and P/E ratio.

Table 2.5 examples of High NPM and low P/e Ratio for Competing Companies

Company NPM P/E Ratio Conclusion

Reliance Energy 0.1614 16.2Reliance Energy is fundamentally stronger based on this model when compared to Tata Power as its NPM is more and P/E ratio is lesser.

Tata Power 0.1024 19.9

Source Author (created from the data in Table 2.4).

Similarly, one can conclude that HPCL is a better bet to put your money over BPCL based on this analogy. Similar is the case between two companies in the Aluminium sector, namely Nalco and Hindalco. Nalco appears to be a better bet with relatively low P/E ratio and better NPM.

Sifting through this data, one can identify such opportunities among the Niftybased stocks themselves. This only leads to conclude that there are many such opportunities available when the entire database of corporations is analyzed.

The author has deliberately ignored the banking stocks as this criterion does not assess them properly and has applied this criterion to manufacturing companies only. Oil companies can be ignored due to the vagaries of government policy and accordingly other companies may be considered. A different variant of Dogs of Dow theory can be practiced using this valuation ratio. Dogs of Dow theory suggests that one should identify the top 5 or top 10 companies for investment amongst the SENSEX or Nifty


basket of companies wherein the dividend yield is the highest. This has proved to be a good investment option over the period of time since this strategy is suggested by Micheal O’Higgins in 1991. Taking cue from this, it is suggested that the same strategy be tried out on SENSEX or Nifty companies wherein the ratio of MCAP/Sales is the least.

SECOND MODEL

MCAP/capital employed can be written as ROCE × P/E Ratio

MCAP/capital employed = number of share × price

capital employed

Multiplying and dividing the above equation by net profit, we get:

MCAP/capital employed

=

number of shares price × net profit×

net profit capital employed

= price/EPS × return on capital employed (ROCE) ...(4)

This model identifies potential and risk free investments that have high ROCE and less P/E ratio, similar to the applications indicated for MCAP/Sales (Table 2.6).

Table 2.6 Risk assessment of Investments Using ROCe approach

MCAP/Capital Employed

Return on Capital Employed

P/E Ratio Action Proposed

High High HighRisky for investment

Value cannot be judged

High LowAttractive for investment

Value cannot be judged

Low HighRisky for investment

Low and needs to be studied in greater depth

Low LowNot so attractive for investment

Source Author.


Table 2.6 depicts the options available for investment and explains the logic for investments. Table 2.7 lists select companies from Business Standard dated 27 April 2007 using the aforementioned approach for companies in the Nifty index.

Table 2.7 ROCe vs P/e Ratio

CompanyReturn on Capital

P/E RatioMCAP/Capital

Employed

Reliance Industries 0.1728 23.7 4.09ONGC 0.3281 13.32 4.37Bharti Airtel 0.2080 50.09 10.42TCS 0.5147 28.63 14.73Infosys 0.3968 29.88 11.85Reliance Comm. 0.06 218.11 13.08ICICI Bank 0.0632 35.73 2.25Wipro 0.3621 28.09 10.17BHEL 0.3337 28.82 9.61ITC 0.3558 26.48 9.42SBI 0.0718 7.05 0.501SAIL 0.3653 13.66 4.99L&T 0.2564 39.63 10.16HLL 0.7827 25.1 19.64HDFC 0.0794 30.36 2.41Suzlon Energy 0.3031 46.37 14.05HDFC Bank 0.0611 28.71 1.75Tata Steel 0.4407 8.12 3.57Satyam Computers 0.3333 21.92 7.30Sterlite Industries 0.1299 5.27 0.68Tata Motors 0.2782 17.10 4.75Bajaj Auto 0.2534 21.24 5.38GAIL 0.2854 11.69 3.33Maruti Udyog 0.3205 14.51 4.65Grasim 0.1873 10.23 1.91HCL Tech. 0.2574 31.28 8.05Sun Pharma 0.1557 29.47 4.58Cipla 0.2972 29.81 8.86Siemens 0.4922 49.54 24.38

(Table 2.7 contd )


M&M 0.2982 13.4 3.99Ambuja Cement 0.4488 10.86 4.87Hindalco 0.1606 10.83 1.74ABB 0.3881 46.21 17.93Nalco 0.4179 6.73 2.81PNB 0.0574 10.45 0.60ACC 0.4282 30.37 13.00Hero Honda 0.6447 14.63 9.43Ranbaxy 0.0669 26.54 1.77Zee 0.0566 49.45 2.80VSNL 0.1118 179.39 20.05Reliance Energy 0.086 14.15 1.21Dr Reddys 0.0905 24.63 2.23BPCL 0.0281 10.65 0.299Tata Power 0.1179 18.52 2.18Glaxo Pharma 0.6169 18.48 11.40IPCL 0.2819 7.33 2.066MTNL 0.0619 10.17 0.62HPCL 0.0288 20.55 0.59Dabur 0.4709 32.61 15.35

Source Business Standard, 27 April 2007.

Converting Table 2.7 into bubble charts with 10–12 companies each with Xaxis being ROCE and Yaxis being P/E ratio will help to clearly know the implications of this model and thus identify which companies are attractive to invest into. In the charts, the bubble size indicates the ratio of MCAP/Capital Employed.

From Figure 2.5 it is clear SBI, SAIL and ONGC are clear choices for investment purpose. Considering the next 10 companies the following chart is depicted (Figure 2.6).

Figure 2.6 indicates that Tata Steel is a clear choice for further investment.

From Figure 2.7 it is clear that Ambuja Cement, Hero Honda, Nalco, Hindalco, M&M, and Grasim are clear choices for further investment as they have higher ROCE and lesser P/E ratio than other Nifty basket of companies.


FIgURe 2.5 ROCe vs P/e Ratio: Illustration 1


Source Based on Table 2.7.



From Figure 2.8 it is seen that Glaxo Pharma is a clear choice for further investment.

One has to be very careful in using this model as inefficient companies, which have high capital employed in business, tend to have this ratio to be less and on the first look are attractive for investment. One has to guard against this possibility in using this model. From Table 2.7, one can consider investigating into the following companies for investment purposes:

HPCL MTNL BPCL Reliance Energy M&M Grasim Sterlite Industries IPCL Tata Steel Nalco Maruti Udyog GAIL ONGC

The above analysis can be extended and compared for peer companies like Infosys and TCS. As one can see in Table 2.7, TCS has a better ROCE but relatively lower P/E ratio than Infosys, which is a case for attractive investment opportunity among the bluechip companies. The case that the author wants to highlight is if these kinds of opportunities are available in Nifty basket of companies for investment, one can look for more such opportunities in mid cap and small cap space when this data analysis is applied, and that can result in more number of investment opportunities.

THIRD MODEL

Another approach is to sort out companies on the basis of MCAP/Assets ratio. This would identify companies wherein MCAP is


less than the assets deployed in business and thus, one would be able to identify value buys using any one of the aforementioned approaches.

It is well known that investors who have timed their decisions by picking up companies that have an MCAP less than the assets of the company, as cheap buys, have been handsomely rewarded. Therefore, one needs to verify the companies after this criterion is met, and check if there are any adverse profitability conditions that need to be looked into. Table 2.8 compiles and analyzes the MCAP/Sales and MCAP/Assets ratios for leading companies in India by bringing data from different sources. The data is shown as summarized, in order to take meaningful decisions.

Table 2.8 Companies Sorted on the basis of MCaP to assets Ratio

CompanySales (Rs

crores)

MCAP (Rs

crores)

MCAP/Sales

Assets (Rs

crores)

Sales/Assets

MCAP/Assets

Suzlon Energy 3,841 35,449 9.23 1,121 3.43 31.62Infosys 9,521 120,312 12.64 9,048 1.05 13.30TCS 13,263 109,505 8.26 8,488 1.56 12.90Nestle 2,475 10,063 4.07 1,037 2.39 9.70Wipro 10,602 80,452 7.59 9,382 1.13 8.58Dabur 1,722 8,096 4.70 999 1.72 8.10HLL 11,579 49,361 4.26 6,351 1.82 7.77ABB 2,963 14,733 4.97 2,319 1.28 6.35Cipla 2,897 18,678 6.45 3,275 0.88 5.70Satyam 4,792 28,957 6.04 5,132 0.93 5.64Bharti Airtel 11,664 109,403 9.38 19,419 0.60 5.63NMDC 3,710 26,366 7.11 4,808 0.77 5.48Container Corpn. 2,433 13,218 5.43 2,485 0.98 5.32

Reliance Energy 3,976 15,417 3.88 2,937 1.35 5.25ITC 10,317 65,280 6.33 13,422 0.77 4.86HCL Tech 4,571 19,054 4.17 4,041 1.13 4.72Pantaloon 1,867 5,912 3.17 1,401 1.33 4.22Motor Ind 2,977 10,627 3.57 2,604 1.14 4.08Guj Amb Cem 3,074 17,734 5.77 4,374 0.70 4.05Asian Paints 3,166 6,762 2.14 1,706 1.86 3.96

(Table 2.8 contd )


ACC 3,318 18,220 5.49 4,669 0.71 3.90Cummins 1,806 4,971 2.75 1,287 1.40 3.86Siemens 3,637 17,606 4.84 4,675 0.78 3.77Hero Honda 8,713 14,478 1.66 3,873 2.25 3.74BHEL 13,442 59,448 4.42 17,505 0.77 3.40Britannia 1,713 2,631 1.54 854 2.01 3.08Maruti 12,106 25,540 2.11 8,420 1.44 3.03Sesa Goa 1,907 4,596 2.41 1,531 1.25 3.00Godrej Ind 2,034 4,791 2.36 1,622 1.25 2.95MMTC 16,393 9,525 0.58 3,629 4.52 2.62Jet Airways 5,693 5,172 0.91 2,118 2.69 2.44L&T 16,537 39,117 2.37 16,312 1.01 2.40Ranbaxy 5,157 13,404 2.60 5,813 0.89 2.31Century Text 2,589 5,441 2.10 2,476 1.05 2.20Lupin 1,685 4,377 2.60 1,998 0.84 2.19

Naga Constructions

1,829 3,884 2.12 1,774 1.03 2.19

PCS 1,954 5,392 2.76 2,519 0.78 2.14Punj lloyd 1,727 4,761 2.76 2,263 0.76 2.10

Bharat Electronics

3,653 9,306 2.55 4,434 0.82 2.10

Dr Reddys 2,355 12,521 5.32 6,131 0.38 2.04Bajaj Auto 8,161 25,584 3.13 12,804 0.64 2.00Bharat Forge 2,971 6,961 2.34 3,524 0.84 1.98Indian Hotels 1,837 8,411 4.58 4,277 0.43 1.97IVRCL 1,712 4,164 2.43 2,150 0.80 1.94HCL Info 11,368 3,676 0.32 1,935 5.87 1.90Grasim 10,213 22,980 2.25 12,158 0.84 1.89ONGC 65,523 172,288 2.63 91,588 0.72 1.88PTC India 3,108 713 0.23 395 7.87 1.81Nalco 4,854 12,947 2.67 7,380 0.66 1.75Tata Motors 23,587 31,618 1.34 18,065 1.31 1.75Reliance 80,055 168,402 2.10 96,871 0.83 1.74Sterlite 13,102 27,890 2.13 16,403 0.80 1.70United Phos. 1,668 5,636 3.38 3,328 0.50 1.69Shipping Corp. 3,531 4,392 1.24 2,675 1.32 1.64BEML 2,056 3,397 1.65 2,122 0.97 1.60

(Table 2.8 contd )


NTPC 26,985 112,798 4.18 73,193 0.37 1.54Voltas 1,954 3,243 1.66 2,136 0.91 1.52Ashok Leyland 5,329 5,179 0.97 3,692 1.44 1.40M&M 9,807 18,766 1.91 13,525 0.73 1.39Crompton 4,132 6,561 1.59 4,865 0.85 1.35Chambal Fert 3,084 1,438 0.47 2,762 1.12 0.52IOCL 162,418 46,486 0.29 94,058 1.73 0.49Ballarpur 1,908 1,739 0.91 3,599 0.53 0.48Eid Parry 2,892 1,183 0.41 2,462 1.17 0.48

Welspun Guj Stahl

1,787 1,099 0.61 2,290 0.78 0.48

National Fert 3,590 1,400 0.39 2,963 1.21 0.47JSW Steel 6,018 4,911 0.82 11,541 0.52 0.43Jindal Stainless 3,131 1,869 0.60 4,597 0.68 0.41GSFC 2,832 1,372 0.48 3,424 0.83 0.40CEAT 1,744 535 0.31 1,393 1.25 0.38Bhushan Steel 2,716 1,357 0.50 3,536 0.77 0.38BPCL 75,850 11,428 0.15 31,173 2.43 0.37CESC 2,556 2,404 0.94 6,914 0.37 0.35HPCL 75,143 8,763 0.12 25,846 2.91 0.34Indo Rama Synth 1,912 626 0.33 1,862 1.03 0.34Usha Martin 1,796 706 0.39 2,177 0.82 0.32Essar Steel 6,168 3,550 0.58 11,254 0.55 0.32Mukand 1,667 566 0.34 2,133 0.78 0.27Arvind Mills 2,125 1,006 0.47 4,050 0.52 0.25ITI 1,660 1,195 0.72 5,518 0.30 0.22JK Iind 2,078 479 0.23 2,337 0.89 0.20Zuari 3,585 456 0.13 2,243 1.60 0.20Surana Corp. 1,693 45 0.03 271 6.25 0.17STC India 7,595 418 0.06 2,698 2.82 0.15Uttam Galva 1,788 239 0.13 1,928 0.93 0.12Ispat Ind 4,914 1,295 0.26 11,983 0.41 0.11National Steel 1,911 61 0.03 787 2.43 0.08Ruchi Soya 5,687 871 0.15 16,513 0.34 0.05Vishal Exports 3,936 79 0.02 14,284 0.28 0.01

Source Data compiled from various magazines.


As one can further identify from Table 2.8, reputed companies like Tata Motors, Reliance, Crompton, and so on, have a reasonable MCAP/Assets ratio and can be studied further for picking up for value investment. The case of Ruchi Soya is an interesting one with low MCAP to assets in business and has been recommended for further investment by other research firms as well. One has to learn to analyze using these models and wait for investment recommendations from leading brokerages, research firms, and so on, and move in with more confidence when both our analysis and their recommendations match. It is generally seen that some companies are asset intensive, like Tata Steel, Reliance, and so on, whereas companies like ITC and HUL, and so on, are less asset intensive in nature. Generally, there are times when market conditions dictate or turn adverse, like in a bear phase. At such times, reputed companies are available at a discount and then this ratio can be used to acquire them at a cheaper price. One needs to wait patiently after acquiring these shares for appreciation in price. Target price for this type of model is difficult to state as one needs to weigh multiple factors such as profitability of the company, profitability growth trends, sales growth rate, and so on. But the approach suggested, as you can see, picks up only those shares that are safe buys. All these approaches work well when the fundamentals of the company are improving and therefore insulate your investments from vagaries of the market. However, care should be taken to exit the stock when fundamentals deteriorate; periodic booking of profits is a safer option.

3Analysis of EPS and Assets

Per Share Model

Generally, investors want to ensure that the companies they invest in have high earnings per share (EPS). To understand

the drivers of EPS in the stock market, the following model depicts with clarity how to analyze the issue:

EPS = net profit/sales × sales/number of shares = NPM × sales per share ...(5)

This simple formula gives the following insights:

Increase in net profit margin can improve EPS. Growth in sales per share is another driver of EPS. This

further can be analyzed as contributing to volume growth or pricing convenience in markets. One needs to investigate if pricing pressure in the market wherein the company is operating can adversely influence the same.

It is observed that volatility in earnings per share from quarter to quarter arises due to these two factors:

1. Fluctuations in NPM.2. Fluctuations in sales per share due to fluctuations in (i) volume growth, and (ii) pricing parameters.

One conclusion that the author has drawn is that there are many companies in India that have a high sales per share figure. This is due to historical reasons such as following a conservative


bonus declaration policy. Sales have kept pace with market reality, but the equity has not grown proportionately.

Table 3.1 is an analysis of this model based on stocks in the Nifty index.

Table 3.1 Nifty basket of Companies with ePS Details

Company EPS NPMSales per

ShareP/E Ratio

Reliance Industries 63.1 0.1112 581 18.7ONGC 61.3 0.2919 224 12.5Bharti Airtel 10.5 0.178 59.22 42.3TCS 26.8 0.2414 115 34.7Infosys 40.4 0.2682 162.43 40.2ICICI Bank 27.2 0.1346 210 27.4Wipro 13.2 0.1954 71 34BHEL 66.5 0.1247 549 29.9ITC 5.7 0.2324 26 25.8SBI 81.7 0.1019 822 16.2SAIL 9.3 0.1415 68 7.4L&T 29.3 0.0586 525 40.6HLL 5.3 0.1197 50.20 32.2HDFC 45.6 0.2826 171 29.6Suzlon Energy 27.8 0.2167 132 37.5HDFC Bank 26.9 0.1529 180.6 32 Tata Steel 58.7 0.2316 261 7.7Satyam Computers 14.9 0.2186 71 24.5Sterlite Industries 8.8 0.0689 131 34.3Tata Motors 33.9 .068 526 20.6Bajaj Auto 97.5 0.1393 740.06 23.0GAIL 25.9 0.1413 193.5 10.4Maruti Udyog 40.9 0.0996 416 18.5Grasim 86 0.119 724 24.2HCL TECH 15.1 0.1856 93 28.9Sun Pharma 23 0.2676 88 34.6Cipla 7.6 0.2122 37 26.3

(Table 3.1 contd )

A n a l y s i s o f E P S a n d A s s e t s P e r S h a r e M o d e l | 51

Siemens 21.4 0.0798 267 34.2M&M 26.5 0.0858 325.6 24.1Ambuja Cement 5.1 0.2196 23 22.2Hindalco 13.6 0.1444 95.93 9.4ABB 50.5 0.074 699 50Nalco 23.2 0.3170 75.33 6.2PNB 44.3 0.1295 352 10.2ACC 20.5 0.097 168.5 22.9Hero Honda 42.1 0.1028 436 16.5Ranbaxy 3.4 0.048 96 47Zee 1.3 0.083 17.68 213VSNL 17.7 0.1377 133 23.2Reliance Energy 29.4 0.1614 187 16.2Dr Reddys 10.9 0.092 121 31.8BPCL 7.7 0.0038 2092 8.4Tata Power 22.7 0.1024 233 19.9Glaxo Pharma 32.2 0.2081 174 27.4IPCL 35.2 0.0988 363 7.1MTNL 8.7 0.105 88.26 17.4HPCL 11.6 0.00569 2107 5.9Dabur 3.0 0.1393 23.39 37.4

Source Capital Market, 14 January 2007.

One can see that sales per share for the Nifty group of companies can vary from a figure as low as 17.68 to as high as 2107. Selecting companies that have high ratio ensures that their EPS is correspondingly high and one can look out for winners across this spectrum (provided they follow liberal dividend payout policy and bonus policy). This can be seen from the following bubble charts wherein NPM is on the Xaxis and sales per share is on the Yaxis. The bubble size indicates earnings per share magnitude. Figures 3.1 and 3.2 show that SBI, BHEL, and Reliance Industries have very high sales per share and their equity has not grown in proportion with sales. They have more potential to reward investors with bonus shares.


Figure 3.1 NPM vs Sales per Share: illustration 1

Source Created from data in Table 3.1.

Figure 3.2 NPM vs Sales per Share: illustration 2

Source Created from data in Table 3.1.

DiviDEnD YiElD MoDEl AnD MCAP/SAlES MoDElS in PrACtiCE for PHArMA inDuStrY

Table 3.2 analyzes companies in the ETLifex basket of companies sorted on the basis of dividend yield criteria in the descending order of dividend yield among pharma companies.


Table 3.2 eT-lifex basket of Companies

Company FV CMP DIV% DIV Yield MCAP Sales MCAP/Sales

Novartis 10 323 200 6.19195 1033 525 1.967619048Wyeth 10 494 250 5.060729 1123 286 3.926573427Abbott 10 474 175 3.691983 687 507 1.355029586Glaxo 10 1196 280 2.341137 10130 1470 6.891156463Ranbaxy 5 390.75 170 2.175304 14570 3575 4.075524476Unichem 5 255 100 1.960784 966 453 2.132450331Cadila 5 321.6 120 1.865672 4039 1246 3.241573034Alembic 2 56 50 1.785714 789 625 1.2624Torrent 5 192 50 1.302083 1628 687 2.369723435Aventis 10 1275 160 1.254902 2937 808 3.63490099Wockhardt 5 399.6 100 1.251251 4371 960 4.553125Pfizer 10 845 100 1.183432 2522 660 3.821212121Orchid 10 262 30 1.145038 1756 873 2.011454754Nicholas 2 269.2 150 1.114413 5625 1406 4.000711238Cipla 2 204.95 100 0.975848 15931 2897 5.499137038Lupin 10 707 65 0.919378 5680 1596 3.558897243IPCA 10 619 55 0.88853 1548 769 2.013003901Dr Reddys 5 663.45 100 0.753636 11476 217 52.88479263Plethico 10 341 25 0.733138 1163 221 5.262443439Astrazeneca 2 661 200 0.605144 1654 225 7.351111111Matrix 2 198.85 60 0.60347 3062 667 4.590704648Sun Pharma 5 977.3 110 0.562775 19100 1681 11.36228435Biocon 5 459.5 50 0.54407 4595 687 6.688500728Dabur Pharma 1 62 20 0.322581 974 255 3.819607843Strides 5 316 20 0.316456 1108 318 3.48427673Dishman 2 236 35 0.29661 1742 216 8.064814815Divis 10 3853.2 100 0.259525 4975 266 18.70300752Panacea Biotek 1 428 100 0.233645 2818 536 5.257462687Aurobindo 5 690.45 30 0.21725 3683 1370 2.688321168Glenmark 2 636.85 35 0.109916 7623 562 13.56405694

Source ETLifex, The Economic Times, 12 May 2007.Note FV = Face Value, CMP = Current Market Price.

Using the criterion of dividend yield in Table 3.2, one can find that the shares attractive for investment are the following ones:


Novartis Wyeth Abbott

All are multinationals offering steady dividends to investors.If we shortlist companies in Table 3.2 based on MCAP/Sales,

the following companies are good for investment.

Novartis Abbott Alembic

It can be seen that both dividend yield and MCAP/Sales recommend Novartis and Abbott as safe investment bets and accordingly one can plan.

Another approach for identifying companies is using more than one criterion for identification of companies for investment:

Identify companies that have ROCE > 12 percent and also P/E ratio < 12.

Identify companies that have pricetobook value ratio < 1.5 and dividend percent > 50 percent.

Identify companies that have NPM > 10 percent and P/E ratio > 12.

Identify companies that have sales above Rs 500 crore and P/E ratio < 12.

List down companies that have sales and earnings growth rate > 20 percent.

Identify companies that have sales above Rs 500 crore and P/E ratio < 10.

Identify companies that have consistent increase in EPS for the last four quarters.

Developing these kinds of criteria would help the investors to identify and compare stocks that are inherently valuable and then proceed with investment depending upon market conditions. Learning to sift through data using multiple criteria filters out companies and helps us to see clearly who are likely to be winners in the capital market.


WHEn tHESE filtErS ArE APPliED, HoW to DECiDE WHEn to EXit?

Generally, whatever may be the criterion, it should have sound common sense and be intuitively obvious to anyone investing in the company. For example, if we are analyzing the company based on dividend yield or ROCE, and so on, then we should become alert when these metrics turn adverse or are likely to turn adverse for the company when results are expected or announced. Therefore, one should learn to revisit the investment decision whenever fresh evidence is available and one should take a call whether to continue to hold on to the investment or book profit/loss. This is the discipline that Warren Buffett has mastered and practices religiously. The author also has failed to practice this discipline at times and some of the decisions have turned adverse due to the fact that proper decisions were not taken when required.

Cash Earnings Per Share Model

Till now, one has seen the analysis involving EPS and how it can be used to judge the companies for investment purposes. However, there is another way to look at the investment opportunity and that is through analysis of cash earnings per share (CPS) and EPS. Capital Market magazine gives both these figures for all the companies listed in its scoreboard. To understand the essence of this approach one needs to define CPS:

CPS = operating cash flow/number of shares issued

To simplify the concept, CPS is nothing but EPS + depreciation per share. However, in essence, the CPS involves nothing but EPS plus amortization of goodwill and other intangible items. The advantage of using CPS is that this figure is not as susceptible to accounting manipulations as net income or EPS. The author proposes further research on the stocks wherein the difference between CPS and EPS is more than the dividend per share of


the company by a substantial margin. This may throw some light on future prospects of the companies and their growth plans. If one finds that the depreciation provided is good enough only to replace the existing assets without much increase in the productive capacity of assets, then one needs to be careful with such companies and look for other companies wherein there is scope for growth in the productive capacity and related assets. Table 3.3 analyzes the companies listed in Capital Market from this perspective.

Table 3.3 CPS analysis of Select Stocks

Company CPS EPSCPS-EPS = Depn/Share

Face Value

Divi dend %Dividend per Share

Carborandum Universal

7.3 5.5 1.8 2 75 1.5

Grindwell Norton

11.2 9.0 2.2 5 160 8

Wendt India 49.5 40.3 9.2 10 175 17.5

Madras Aluminium

89.9 80.6 9.3 10 120 12

Eicher Motors 32.2 17.7 14.5 10 290 29Tata Motors 61.3 46.1 15.2 10 150 15

Source Capital Market, 21 April to 4 May 2008.

The above analysis throws open the growth opportunities available for productive capacity and related investments versus dividend declared to please the shareholders for their current investment. This perspective and further study of the company will give key answers about the company’s management and its plans. Similarly, this analysis can be performed on other companies listed in Capital Market magazine to determine the opportunities available.

Assets Per Share Model

Another approach can be comparing the current stock price with assets per share of the company and then identifying companies


that are value buys if the current stock price is less than assets deployed in business per share. Table 3.4, which analyzes the companies based on this approach, has been prepared in the following steps:

1. First of all, companies that have declared a dividend of 100 percent are listed down for further analysis.

2. Then assets/share is calculated by reading the balance sheets of these companies in comparison to market price for better identification of valuable companies for investment.

Table 3.4 analysis of Companies wherein Dividend is High and assets Per Share is low

Company Div % EquityFace Value

AssetsAssets/Share

Current Market Price

(CMP) as on

26 April 2007

Divi-dend Yield

%

CMP/Assets per

Share

Karur Vysya

100.00 18.00 10.00 7884.85 4380.47 267.00 3.75 0.060952

Aarti Inds 101.00 36.39 5.00 430.70 59.18 28.45 17.75 0.48075

Electro Steel

125.00 20.76 10.00 983.50 473.75 394.00 3.17 0.831666

Pricol 100.00 9.00 1.00 281.25 31.25 33.00 3.03 1.056

Ramco Industries

100.00 4.33 10.00 290.66 671.27 735.00 1.36 1.094939

Nippo Batteries

200.00 3.75 10.00 111.00 296.00 330.00 6.06 1.114865

Sundaram Fasteners

170.00 10.51 1.00 603.00 57.37 65.00 2.62 1.132919

IHP 150.00 4.85 10.00 167.13 344.60 450.00 3.33 1.30587D link 160.00 6.00 2.00 160.00 53.33 74.00 4.32 1.3875IBP 100.00 22.15 10.00 659.57 297.77 414.00 2.42 1.390315Hindalco 200.00 115.89 1.00 11466.58 98.94 149.00 1.34 1.505908

Chemfab Alkalies

100.00 3.47 5.00 43.96 63.34 96.00 5.21 1.51556

(Table 3.4 contd )


Triton Valves

140.00 0.32 10.00 25.04 782.50 1190.00 1.18 1.520767

Tide Water

100.00 0.87 10.00 99.57 1144.48 1905.00 0.52 1.664507

TVS Motor

130.00 23.75 1.00 865.67 36.45 61.00 2.13 1.673559

Sundaram Brake

100.00 2.71 10.00 77.45 285.79 525.00 1.90 1.836992

Rajesh Exports

100.00 7.39 2.00 790.00 213.80 404.00 0.50 1.889595

Blue Star 100.00 17.99 10.00 185.70 103.22 220.00 4.55 2.131287

Ultramarine

150.00 5.84 2.00 57.00 19.52 43.00 6.98 2.202807

Ashok Leyland

100.00 118.93 1.00 2048.28 17.22 39.70 2.52 2.305115

Rico Auto 100.00 12.28 1.00 241.47 19.66 48.00 2.08 2.441049Mastek 150.00 6.97 5.00 165.00 118.36 306.00 2.45 2.585236Clariant 110.00 11.93 10.00 107.86 90.41 270.00 4.07 2.986371

NRB Bearings

100.00 9.89 2.00 144.62 29.25 90.00 2.22 3.077375

Swaraj Engines

225.00 12.42 10.00 59.00 47.50 151.00 14.90 3.178678

Elgi 100.00 7.82 1.00 119.76 15.31 50.00 2.00 3.264863

GMM Pfaudler

100.00 2.83 2.00 59.00 41.70 138.00 1.45 3.309661

Madras Cement

100.00 12.08 10.00 1025.81 849.18 2924.00 0.34 3.44332

Godfrey Philips

220.00 10.40 10.00 389.25 374.28 1312.00 1.68 3.505408

HCL Tech.

800.00 64.00 2.00 2956.00 92.38 332.00 4.82 3.594046

Patel Engg.

100.00 5.00 1.00 435.00 87.00 355.00 0.28 4.08046

Kirloskar Oil

125.00 19.42 2.00 614.00 63.23 260.00 0.96 4.111726

BEML 100.00 36.74 10.00 810.00 220.47 971.00 1.03 4.404264HCL Info 310.00 33.59 2.00 517.00 30.78 136.00 4.56 4.418027

(Table 3.4 contd )


Patni Computers

125.00 27.56 2.00 1345.00 97.61 432.00 0.58 4.425993

ZEE 100.00 41.25 1.00 2658.00 64.44 287.00 0.35 4.454007

Hercules Hoists

120.00 0.80 10.00 26.00 325.00 1450.00 0.83 4.461538

Bajaj Auto 250.00 101.18 10.00 5361.34 529.88 2436.90 1.03 4.598954

Manugraph

100.00 6.00 2.00 106.00 35.33 165.00 1.21 4.669811

Satyam 250.00 64.73 2.00 3226.00 99.68 466.00 1.07 4.675167Siemens 140.00 33.14 10.00 783.00 236.27 1118.00 1.25 4.731867

Balaji Tele Films

800.00 13.04 2.00 213.00 32.67 168.00 9.52 5.142535

GG Dandekar

500.00 0.48 1.00 8.00 16.67 87.00 5.75 5.22

Carborandum

100.00 18.68 2.00 239.78 25.67 147.00 1.36 5.725999

M&M 130.00 236.08 10.00 3064.88 129.82 762.00 1.71 5.869494

Auto Axles

125.00 15.11 10.00 135.37 89.59 561.00 2.23 6.261882

Bosch Chassis

120.00 10.40 10.00 139.96 134.58 917.00 1.31 6.813947

Pidilite 100.00 25.24 1.00 418.41 16.58 116.00 0.86 6.997538ITC 310.00 375.51 1.00 8140.97 21.68 162.00 1.91 7.472404

Hero Honda

1000.00 39.94 2.00 1695.14 84.88 687.00 2.91 8.093367

Bharat Forge

125.00 44.15 2.00 860.43 38.98 321.00 0.78 8.235504

BEL 112.00 80.00 10.00 1609.00 201.13 1657.00 0.68 8.238658

Motherson Sumi

100.00 23.48 1.00 244.35 10.41 111.00 0.90 10.66618

Wipro 250.00 284.33 2.00 4954.00 34.85 556.00 0.90 15.95554Cummins 200.00 39.60 2.00 336.00 16.97 291.00 1.37 17.14821Infosys 230.00 137.26 5.00 1569.00 57.15 2018.00 0.57 35.30793Praj 108.00 16.22 2.00 43.00 5.30 485.00 0.45 91.47326Iflex 100.00 385.05 5.00 1125.00 14.61 2430.00 0.21 166.3416L&T 27.07 1375.00 2.00 5228.00 7.60 1688.00 0.03 221.9778

Source Compiled from various sources such as Capital Market magazine.


From Table 3.4 it can be seen that the following companies are value buys as their current market prices are very near to their assets deployed in business per share and are less than 1.5 times assets per share.

Aarti Industries Electro Steel Castings Pricol Ramco Industries Nippo Batteries Sundaram Fasteners

From this list it can be seen that these companies have steady businesses that give reasonable returns and their managements are conservative in approach unlike the other companies. After the above shares are identified, usually one needs to verify how the profitability of the company is likely to vary and at what level is it at currently, and so on, and only then investment decisions need to be taken.

4Assessing Indebtedness

of a Company

T his chapter shows an approach using the data published in Business Standard daily on how to calculate the debt employed

by companies in their business.

Capital employed/net worth = (price/book value) / (ROCE × P/E ratio) ...(6) = (price/net worth per share) / (net profit/

capital employed × price/net profit per share)

On canceling the common terms, the above formula gives the ratio of capital employed by net worth of any company.

TABLE 4.1 Capital Employed/Net Worth Data

CompanyPrice/Book

ValueROCE P/E Ratio

Capital Employed/ Net Worth

3i Infotech 4.16 0.0694 15.74 3.8ABB 19.52 0.3881 46.21 1.08ACC 4.96 0.4282 30.36 0.38Aditya Birla Nuovo 5.00 0.0907 45.49 1.21Amtek Auto 3.55 0.0804 25.72 1.72Arvind Mills 0.61 0.08 11.26 0.67Ashok Leyland 3.45 0.2359 12.98 1.13BEML 4.03 0.3206 18.46 0.68

(Table 4.1 contd )


BEL 6.50 0.43 22.18 0.67Bharat Forge 6.16 0.1714 28.69 1.24BHEL 8.42 0.3337 28.87 0.87Biocon 5.15 0.1801 24.97 1.14BPCL 1.34 0.0281 10.65 4.47Canara Bank 1.29 0.0625 6.80 2.99Century Textiles 6.85 0.1392 27.85 1.76Cipla 3.85 0.2972 29.81 0.43CMC 7.30 0.2313 24.46 1.29Crompton 14.77 0.2896 33.17 1.53Cummins 7.28 0.3112 31.10 0.75Dabur 19.59 0.4709 29.05 1.43Divis 14.78 0.2275 72.95 0.89Dr Reddys 2.30 0.0905 23.3 1.09GE Shipping 1.28 0.2286 4.31 1.29GAIL 2.15 0.2854 9.70 0.77Glaxo Pharma 8.58 0.6169 18.61 0.74Glenmark 17.79 0.0981 30.12 6.02Grasim 3.73 0.1873 10.32 1.93Gujarat Ambuja Cement 5.36 0.4488 11.24 1.06HCC 2.89 0.0894 79.36 0.40HCL Tech 8.76 0.2574 33.3 1.02HDFC 7.79 0.0794 27.54 3.56HDFC BANK 5.14 0.0611 28.76 2.92Hero Honda 5.49 0.6447 15.80 0.53Hind Zinc 3.76 0.5710 6.45 1.02Hindalco 1.25 0.1606 11.50 0.67HLL 15.81 0.7827 22.73 0.88Idea Cellular 22.42 0.0934 60.72 3.95I-flex 8.00 0.2095 50.65 0.75India Cements 3.26 0.0825 9.24 4.27Indian Hotels 4.72 0.1375 33.68 1.02Infosys 10.16 0.3721 29.35 0.93IPCL 1.68 0.2819 7.72 0.77ITC 6.88 0.3558 27.05 0.71IVRCL 7.3 0.1215 39.02 1.54

(Table 4.1 contd )

A s s e s s i n g I n d e b t e d n e s s o f a C o m p a n y | 63

JSW Steel 1.90 0.1971 7.41 1.3KPIT Cummins 5.41 0.1403 20.51 1.88L&T 5.13 0.2564 39.96 0.50Lupin 6.41 0.1674 18.45 2.07M&M 5.87 0.2982 12.76 1.54Mahindra Gesco 3.41 0.0683 124.96 0.72Maruti Udyog 3.44 0.3205 14.83 0.72Moser Baer 2.29 0.0268 61.64 1.38Mphasis BFL 9.74 0.1544 45.29 1.39Nagarjuna Constructions 1.89 0.1119 34.7 0.49Nalco 2.75 0.4179 6.91 0.95NIIT Tech 9.68 0.2471 31.3 1.25NTPC 2.91 0.1237 22.4 1.05ONGC 2.40 0.3281 12.63 0.58Polaris 2.97 0.0394 24.9 3.02Punj Lloyd 17.48 0.079 85.94 2.57Rajesh Exports 7.35 0.0708 20.95 4.95Ranbaxy 6.26 0.0907 25.54 2.7Rei Agro 2.03 0.1310 10.13 1.52Reliance Capital 4.22 0.1381 31.70 0.96Reliance Energy 1.35 0.086 13.95 1.12Reliance Industries 5.2 0.1728 25 0.88SAIL 4.61 0.3653 14.29 0.88Satyam 5.22 0.2728 21.5 0.88Sesa Goa 4.13 0.7407 10.28 0.54SCI 1.37 0.2082 5.55 1.18Siemens 19.12 0.4922 53.01 0.73Sun Pharma 12.84 0.1557 27.97 2.94Suzlon Energy 8.82 0.3031 37.8 0.76Tata Motors 5.22 0.2782 16.75 1.12Tata Power 2.35 0.1179 18.42 1.08Tata Steel 3.39 0.4407 8.66 0.88Tata Tea 4.12 0.1787 11.13 2.07TCS 15.16 0.5147 28.80 1.02Tech Mahindra 20.63 0.4025 29.57 1.73Titan 14.38 0.2232 42.16 1.52

(Table 4.1 contd )


Unitech 15.72 0.1590 523.28 0.188United Phosphorus 4.84 0.1130 21.16 2.02Voltas 8.23 0.3063 15.53 1.73VSNL 2.15 0.1118 186.36 0.10Welspun Gujarat 3.28 0.1102 14.88 2.00Wipro 8.53 0.3621 27.15 0.86Zee 7.83 0.0566 49.82 2.77

Source Business Standard.

WHEN TO APPLY THIS CRITERIA?

It should be borne in one’s mind that this is not a primary criteria for investment, but only identifies and segregates companies that have a high debt content and those with low debt content. Then how do we decide when to invest in the companies? The higher this ratio, the higher the debt content for that company, as against any other company with a lower ratio (and therefore) having lower debt content. Therefore, one should avoid investing in companies that have a high ratio of this parameter, and in addition, one should be careful in making investments in such companies when interest rates are likely to go up. Then the safe bet when interest rates are going up are the ones with low debt content. If this principle is kept in mind then sound investments can be made using the above criteria; irrespective of bull market or bear market one can invest in the company.

The author has presented this ratio as the data for the aforementioned formula is readily available in Business Standard newspaper. In the usual case, if debt–equity ratio is to be calculated, one needs to go through the balance sheet of the company and then calculate, which is more time consuming and involves more effort. Therefore, the idea in presenting this concept to the reader is to make use of the data given in the Business Standard newspaper to identify companies with high and low debt contents rather than looking for individual companies’ annual reports, which is time consuming. After the initial screening of companies using this approach, one can selectively look for annual reports of companies that are identified using this approach.

A s s e s s i n g I n d e b t e d n e s s o f a C o m p a n y | 65

Capital employed/net worth is a ratio that reflects the debt employed by the company. The data from Business Standard for 200 companies published on Fridays helps one to analyze companies and identify which companies have less debt and are thus less risky to invest in. Thus, the earlier analysis (Table 4.1) identifies the following companies for our consideration based on very low ratio of capital employed by net worth, that is, less than 2:

ACC Arvind Mills BEML BEL BHEL Cipla

Further profitability analysis and outlook analysis for the company can be done to identify which of these companies is good for investment using any of the criteria suggested in this book.

5Identifying Companies Based

on Quarterly Results

O ne can purchase the Capital Market fortnightly magazine and then analyze the data of companies as described next.Identify companies that have improved their current quarter’s

operating profit margin (OPM) when compared to previous financial year’s OPM. From this set of companies identify those companies wherein sales growth in current quarter is more than previous year’s growth rate. These two filters would give a set of companies wherein investment for this quarter can be beneficial to the investor till the next set of quarterly results are out. These criteria assume that past performance is an indicator of the future and thus one has to learn to shuffle the portfolio depending on how quarterly results compare for different companies using this approach. Generally, the company’s stock price adjusts to the results announced over time and if quick and proper judgment of the market is done, the investor can benefit. These criteria generally identify solid companies wherein capital gains appreciation is assured for the investor. The investor can then further narrow down choices to invest by adding additional criteria such as whether the company is a market leader in its category or not, and so on. This type of analysis can be done using the data in Capital Market magazine published fortnightly and available in market.

Time horizon for investment using this approach is one quarter only and the investment decision needs to be reviewed particularly in the context of fresh evidence in terms of its most

I d e n t i f y i n g C o m p a n i e s B a s e d o n Q u a r t e r l y R e s u l t s | 67

recent quarterly results. The author advocates this technique as short-term trading technique depending on how you optimize your returns based on the quarterly results. The assumption for investment is that the better the results are for a company in a quarter, the better it is to invest in that company irrespective of its P/E ratio or any other parameter for that quarter in the company, so that one can capitalize on the positive developments of the company. In the case of bear market, the returns are likely to be muted and small as compared to bull market, where the swing in prices can be more and better returns can be achieved. However, one should be careful to invest in companies wherein not one but both the parameters indicated in Table 5.1 improve.

Table 5.1 analysis of OPMs of Select Companies

CompanyPrevious Year’s Sales Growth

Rate

Previous Year’s oPM

Current Quarter Sales

Growth

Current Quarter oPM

Reliance 23 17.7 37 16 TCS 39 29.1 47 29.2 Infosys 32 32.3 51 32.2 ICICI Bank 45 64.5 59 68.1 Wipro 41 24.3 47 23.9 SBI 9 56.8 8 67.2 HDFC Bank 49 49.2 58 56.5 Tata Motors 19 10.7 37 11.3 Bajaj Auto 30 15.4 30 15 Maruti 10 13.6 13 13.9 Sun Pharma 40 24.8 29 24.7 Ambuja Cement 34 32.3 52 36.1 M&M 22 8.5 30 14.8 PNB 4 57.3 14 71.8 Hindalco 19 20.5 74 21.3 ACC –19 16 37 27 Nalco 18 53.2 38 60.7 Cipla 33 20.7 33 25.4

(Table 5.1 contd )


Ranbaxy –4 2.3 34 17.7 BPCL 31 1.2 56 6.5 Hero Honda 17 15.6 3 12.7 Dr Reddys 29 13.9 78 36.3 HPCL 18 1.1 45 6.8 Glaxo 8 26.9 4 31.7

Source Capital Market, 1–14 January 2007 for Nifty basket of companies.

It can be seen that companies like ICICI bank, HDFC Bank, and Tata Motors have improved OPM margins in the current quarter when compared to the last financial year and can be held till future quarter results are out. If this trend sustains, the shares can further be held for more quarters.

While using the above approaches one should take care to follow all these guidelines, which are a must for a fresher. Some general guidelines to keep in mind in finalizing the investments are the following:

You should invest only in top-200 traded shares, which are listed in financial dailies.

One should be careful to invest only in market leaders of the respective sectors, which these criteria throw light on. This is simple—identify the companies by looking at the capital market results as to which is the company which has highest sales in each sector of the classification given by Capital Market magazine and then see if its OPM and sales have improved both over the last quarter and last financial year.

One should have the patience to wait for identification of value and for the market to realize the potential of the company identified by these criteria. Invariably, one finds that these systematic analyses identify multi-baggers before others provided one is consistent and regular in investments. Using this approach, the author identified IVRCL in the year 2001/2002 at a price of Rs 50 when its order book position was several crores. However, the author after listening to the advice of his stock broker avoided building

I d e n t i f y i n g C o m p a n i e s B a s e d o n Q u a r t e r l y R e s u l t s | 69

a position in the stock as it trades in small volumes and is illiquid in nature. But the market realized the stock’s worth later on and the upward journey of the stock began, thus forcing the author to regret his decision. This approach if applied consistently brings out and discovers multi-baggers (as Peter Lynch, the Wall Street investor, calls them) much before the market unearths them. One needs to be patient and wait for their turn to unfold to book profits.

6Sector-wise Profitability Analysis

How do we identify which sectors have a better potential for investment? Table 6.1 analyzes the sectors as per classification

done in the Capital Market fortnightly magazine and lists down the number companies that are competing in each sector.

Table 6.1 Number of Companies in Key Sectors in India

Sector Number of CompaniesTea 17Finance: Term Lending 5Transport: Airlines 4Diamond Cutting/Jewellery 18Cement: South India 13Breweries 18Automobiles: Tractors 5Telecom Equipment 17Textiles: Composite 14Textiles Manmade 20Leather 11Pharma-Bulk: Indian & Formulations 43Finance and Investment 137Computers: Software Converts 10Refineries 10Cement: North India 18Pharma: Indian Formulations 31

(Table 6.1 contd )

S e c t o r - w i s e P r o f i t a b i l i t y A n a l y s i s | 71

Pesticide-Agro: MNC 15Dyes & Pigments 11Diversified: Medium/Small 10Photographic 1Diversified: Large 4Diversified: Mega 5Computers: Hardware 18Petrochemicals 16Construction 90Fasteners 4Textiles: Spinning—Synthetic/Blended 12Solvent Extraction 17Telecom: Service Provider 11Steel: Large 22Cables: Power 10Electronics Components 21Electrode: Graphites 3Packaging 35Tyres 11Engines 4Mining/Minerals 31Textiles: Jute 4Castings & Forgings 31Banks: Public Sector 22Fertilizers 20Electrodes: Welding 5Personal Care: MNC 6Auto Ancillaries 76Plastics Products 32Textiles: Silk 5Textiles: Processing 31Steel: Medium 52Oil Drilling 10Paints 7Food Processing: Indian 37Personal Care: Indian 9

(Table 6.1 contd )


Banks: Private Sector 18Textile Products 59Air Conditioners 4Entertainment 55Paper 31Pharma: MNC 10Glass & Glass Products 11Pharma: Indian Bulk 26Chloro Alkalies 9Compressors/Drilling Equipment 5Bearings 9Computers: Education 7Automobiles: Scooters 6Automobiles: LCV/HCV 5Chemicals 79Engineering 67Finance: Housing 10Aluminium 16Textile Machinery 5Automobiles: Cars 2Computers-Software: Medium/Small 130Textiles: Cotton Blended 58Cigarettes 4Cables: Telephone 10Computers-Software: Large 10Power Generation 15Transmission Lines 4Engineering Turnkey 18Healthcare 13Ceramic Tiles 14Abrasives 4Steel: Sponge Iron 10Trading 45Cement Products 7Dry Cells 5Steel: Pig Iron 4

(Table 6.1 contd )


Refractories 3Electric Equipment 41Pumps 7Cycles 2Pesticides-Agro: Indian 15Shipping 11Travel Agencies 3Food Processing: MNC 3Automobiles: Motorcycles 4Miscellaneous 101Hotels 33Sugar 38Couriers 2Detergents 3Moulded Luggage 1Printing & Stationery 11Domestic Appliances 10Electronics: Consumer 7Aquaculture 3

Source Capital Market, 22 December 2006.

Table 6.2 OPM analysis of Key Sectors

Sector MCAP* SalesMCAP/ Sales

OPM of Previous

Year (A)

OPM of Current Quarter

(B)

Ratio of OPMS (B)/(A)

Tea 8573 3368 2.55 2.5 28.7 11.48

Finance: Term Lending

860 2049 0.42 31 86.2 2.780645

Transport: Airlines

7319 7358 0.99 6.3 16.8 2.666667

Diamond Cutting/Jewellery

6410 12938 0.50 2 4.3 2.15

Cement: South India

14149 4392 3.22 15.7 33.3 2.121019

(Table 6.2 contd )


Breweries 15779 5067 3.11 7.4 15.3 2.067568

Automobiles: Tractors

27318 11033 2.48 7.6 13.8 1.815789

Telecom Equipment

4654 3713 1.25 –1.9 –3.2 1.684211

Textiles: Composite

2424 2366 1.02 7.6 12.4 1.631579

Textiles Manmade

14457 10271 1.41 9.5 15.3 1.610526

Leather 2374 2040 1.16 6.5 9.7 1.492308

Pharma-Bulk: Indian & Formulations

107280 23387 4.59 15.1 22.3 1.476821

Finance & Investment

53139 14458 3.68 34.8 51.2 1.471264

Computers: Software Converts

1922 1354 1.42 10.2 15 1.470588

Refineries 266734 455677 0.59 5.7 8.1 1.421053

Cement: North India

66915 16217 4.13 20 28.1 1.405

Pharma: Indian Formulations

5469 2647 2.07 13.3 18.52 1.392481

Pesticide-Agro: MNC

3220 1775 1.81 12.6 17.5 1.388889

Dyes & Pigments

827 1761 0.47 7.4 10.2 1.378378

Diversified: Medium/Small

13578 2014 6.74 11.8 15.9 1.347458

Photographic 111 381 0.29 7 9.3 1.328571

Diversified: Large

4213 3754 1.12 12.8 17 1.328125

Diversified: Mega

38924 15032 2.59 13.9 18.4 1.323741

Computers: Hardware

9579 7349 1.30 9.4 12.2 1.297872

(Table 6.2 contd )


Petro-chemicals 18154 19922 0.91 13.2 17.1 1.295455

Construction 122601 21202 5.78 13.8 17.7 1.282609

Fasteners 2250 1477 1.52 12.1 15.4 1.272727

Textiles-Spinning: Synthetic/Blended

2010 2900 0.69 10 12.7 1.27

Solvent Extraction 3525 11454 0.31 3.5 4.4 1.257143

Telecom: Service Provider

236215 21975 10.75 26.1 32.8 1.256705

Steel: Large 96132 97249 0.99 19 23.7 1.247368

Cables: Power 1212 1562 0.78 9.1 11.3 1.241758

Electronics Components 34304 11113 3.09 13 16.1 1.238462

Electrode: Graphites 1595 1143 1.40 17.9 22 1.22905

Packaging 9007 6372 1.41 10.8 13.2 1.222222

Tyres 6208 12720 0.49 6.5 7.9 1.215385

Engines 9989 4088 2.44 11.7 14.2 1.213675

Mining/Minerals 81107 21887 3.71 32.4 39 1.203704

Textiles: Jute 227 438 0.52 11.3 13.6 1.20354

Castings & Forgings 11452 5879 1.95 13.4 16.1 1.201493

Banks: Public Sector 160166 138623 1.16 60.2 71.5 1.187708

Fertilizers 18286 33680 0.54 8.7 10.3 1.183908

Electrodes: Welding 954 626 1.52 17.3 20.1 1.16185

Personal Care: MNC 59540 13547 4.40 13.6 15.8 1.161765

Auto Ancillaries 36722 21579 1.70 12.4 14.4 1.16129

Plastics Products 4280 4094 1.05 9.1 10.4 1.142857

(Table 6.2 contd )


Textiles: Silk 1776 847 2.10 17.8 20.3 1.140449

Textiles: Processing

7670 6972 1.10 12.9 14.7 1.139535

Steel: Medium 4326 3963 1.09 9.1 10.3 1.131868

Oil Drilling 192054 49188 3.90 44 49.5 1.125

Paints 12115 5771 2.10 12 13.5 1.125

Food Processing: Indian

3956 5613 0.70 10 11.2 1.12

Personal Care: Indian

16833 3653 4.61 15.9 17.8 1.119497

Banks: Private Sector

155588 42253 3.68 60 67 1.116667

Textile Products

4552 11466 0.40 11.2 12.5 1.116071

Air Conditioners

2605 2054 1.27 7.8 8.7 1.115385

Entertainment 42307 5305 7.97 19.6 21.8 1.112245

Paper 4581 7272 0.63 16.1 17.7 1.099379

Pharma: MNC

20778 5155 4.03 23.4 25.7 1.098291

Glass & Glass Products

4739 1719 2.76 13.6 14.8 1.088235

Pharma: Indian Bulk

14494 5831 2.49 17 18.5 1.088235

Chloro Alkalies

3536 2934 1.21 26.6 28.9 1.086466

Compressors/Drilling Equipment

3825 1749 2.19 11.7 12.7 1.08547

Bearings 4233 2058 2.06 16 17.3 1.08125

Computers: Education

3147 601 5.24 17.5 18.7 1.068571

Automobiles: Scooters

26871 8232 3.26 13.3 14.1 1.06015

Automobiles: LCV/HCV

40578 28783 1.41 9.5 9.9 1.042105

(Table 6.2 contd )


Chemicals 32023 35042 0.91 5.1 5.3 1.039216

Engineering 28062 11360 2.47 12.8 13.2 1.03125

Finance: Housing

42210 6248 6.76 91.7 94.1 1.026172

Aluminium 34749 17286 2.01 29 29.7 1.024138

Textile Machinery

8432 1473 5.72 15.4 15.7 1.019481

Automobiles: Cars

27256 12472 2.19 12.9 13.1 1.015504

Computers-Software: Medium/Small

52052 9859 5.28 22.6 22.9 1.013274

Textiles: Cotton Blended

9720 13559 0.72 15.2 15.4 1.013158

Cigarettes 66373 10965 6.05 31.8 32.2 1.012579

Cables: Telephone

3768 2115 1.78 12.1 12.2 1.008264

Computers-Software: Large

406879 42063 9.67 27.2 27.3 1.003676

Power Generation

161678 44404 3.64 25.3 25.3 1

Transmission Lines

4983 3452 1.44 12.6 12.6 1

Engineering Turnkey

48708 17755 2.74 8.6 8.5 0.988372

Healthcare 3134 1298 2.41 15.4 15.1 0.980519

Ceramic Tiles 1999 1983 1.01 17.3 16.9 0.976879

Abrasives 2553 895 2.85 17.7 17 0.960452

Steel: Sponge Iron

7920 4846 1.63 27 25.7 0.951852

Trading 25104 45579 0.55 1.5 1.4 0.933333

Cement Products

2502 2074 1.21 18.1 16.8 0.928177

(Table 6.2 contd )


Dry Cells 1234 1546 0.80 10.3 9.4 0.912621

Steel: Pig Iron 963 1408 0.68 11.9 10.8 0.907563

Refractories 785 402 1.95 20.2 18.2 0.90099

Electric Equipment

127766 28847 4.43 15.9 14.3 0.899371

Pumps 5579 1477 3.78 13.8 12.3 0.891304

Cycles 1325 1913 0.69 9.7 8.5 0.876289

Pesticides-Agro: Indian

6478 3270 1.98 13.1 11.3 0.862595

Shipping 12062 7715 1.56 40.1 34.5 0.860349

Travel Agencies

919 240 3.83 25.4 21.8 0.858268

Food Processing: MNC

15586 5613 2.78 16.54 14 0.846433

Automobiles: Motorcycles

17078 12186 1.40 12.6 10.2 0.809524

Miscellaneous 76809 37282 2.06 19.1 15.4 0.806283

Hotels 22508 3773 5.97 33.5 27 0.80597

Sugar 12919 15017 0.86 17 13.6 0.8

Couriers 1939 871 2.23 13.4 9.9 0.738806

Detergents 3003 2732 1.10 19.1 13.8 0.722513

Moulded Luggage

346 620 0.56 5.5 3.9 0.709091

Printing & Stationery

3125 2651 1.18 12 7.6 0.633333

Domestic Appliances

1343 5147 0.26 5.9 3.7 0.627119

Electronics: Consumer

10936 10641 1.03 11.6 5.1 0.439655

Aquaculture 57 223 0.26 4 1.2 0.3

Grand Total 3455593 1693652 2.04 16.18 18.59 1.148881

P/E 12.60 10.97

Source Capital Market, 22 December 2006.Notes Figures for MCAP and sales are in Rupees (crores). * as on 22 December 2006.


It can be seen that in Table 6.2, the tea sector has dramatically improved profitability. Other sectors that have improved profitability are the following:

Finance: Term Lending Transport: Airlines Diamond Cutting/Jewellery Cement: South India Breweries Automobiles: Tractors Telecom Equipment Textiles: Composite Textiles Manmade Leather

As a conservative investor, one has to wait and watch the figures and then move in a decisive way. However, other forms of investing also can be tried out, but this approach considers the lag effect of information flow and thus is a sure shot for further investment opportunity in many of the sectors. This ensures that reasonable returns are generated, but not ambitious returns like other approaches project.

It can be seen that the following sectors have very less MCAP/Sales ratio, but simultaneously improved profitability:

Diamond Cutting Refineries Dyes & Pigments Textiles-Spinning: Synthetic/Blended Solvent Extraction Cables: Power

All these sectors have also improved profitability in the current quarter under study. The next question that comes to mind is how to identify companies in these sectors. After identifying the sectors, one should investigate the market leader (the company that has maximum sales in that sector according to the Capital Market magazine) in that sector for possible investment criteria.


Analysis done by the author has identified many companies at an early stage itself. It should be borne in mind that some sectors have less investor fancy than other sectors. Therefore, the price movements of stocks in these sectors tend to be in a narrow range. However, the value in the following shares identified by the author much before they caught the fancy of the bull market and these companies have delivered good returns:

IVRCL Baja Hindustan Havell’s India Rei Agro Rajesh Exports

All these shares were identified much before the market discovered their merit, before the bull market of 2003.

One comment that should be made is that the overall MCAP to sales ratio is around 2.04 and the P/E ratio based on operating profit works out to 12.6 for the last financial year and 10.97 for the current quarter. This suggests that the market is not overheated and has the potential to go up still as P/E is attractively placed and fundamentals justify the risk. However, one needs to worry as and when the fundamentals go out of balance. MCAP to sales ratio is thus one barometer for assessing the health of stock markets in the overall context. From Table 6.2 one can identify the sectors that have low MCAP/Sales ratio and then analyze the leading company in each sector as a probable candidate for investment. This will ensure that we invest in market leaders provided the sectors are attractive to invest. For example, Capital Market dated 21 April–04 May 2008 gives an overall summary of how to assess the overheatedness of the market. Table 6.3 gives a summary of parameters to judge overall heatedness of the stock market and whether the market in aggregate is overvalued or not can be judged by looking at the various parameters summarized in this table.


Table 6.3 Summary of Parameters to Judge Overall Heatedness of the Stock Market

Metric For Full Year TTMOPM % 20.9 22.8

PBDT Margin % 15.2 16.1

P/C Ratio 18.2 15.4P/E Ratio 23.4 18.8Dividend Yield % 1.3Price/Book Value Ratio 4.1

Total Market Capitalization of 2200 Companies

Rs 5302039 crore

Source Capital Market, 21 April–04 May 2008, p. 65.

It can be seen that the OPM has improved in the current year over the previous financial year figures and the trend is encouraging. Similarly this got reflected in the P/E ratio after the correction in the market in January 2008 and the P/E ratio is reasonable and not overheated. Dividend yield is at 1.3 percent, which is less, and the price/book value ratio is only 4.1.

FII HoldIngS: An IndICAtor

Every Thursday, Business Standard gives the list of Foreign Institu-tional Investor (FII) investment into the top-200 traded companies of the previous day. This can be used to analyze how the FIIs are increasing their holding in Indian companies and then one can track the price movement if substantial purchases are done by FII since this is one of the driving forces for a company’s stock price to go up in the Indian markets. The data captured at various periods of time are presented for sample companies so that the reader can also track the same. Table 6.4 gives a snapshot of how FII holdings in different companies have varied over a period of time as compiled from Business Standard daily statistics.


Table 6.4 Variation in FII Holdings Status

Company FII Holding24/11/2005 8/12/2005 23/3/2006 1/5/2008

3i Infotech 4.45 4.45 3.59 5.53Abanlioyd 13.42 16.62ABB 16.4 16.4 16.16 15.79ACC 20.52 20.52 23.74 15.12Aditya Birla Nuovo 17.94Adlabs 10.48 10.48 10.47 5.8Aftek 16.81 16.81 14.89AIA Engg. 5.7Allahabad Bank 14.65 14.65 12.63 18.52Alok 28.47 28.47 29.86Alstom Projects 0.83 2.84Amar Remedies 11.9 11.9 14.75Amtek Auto 36.39 36.39* 36.77 45.79Amtek India 9.99

Source Business Standard, 24 November 2005.

If one periodically monitors FII holdings in companies, one can predict and follow their judgment and unearth good shares for better returns.

7Mutual Funds

IntroductIon to Mutual Funds and Mutual Funds In IndIa

t he origin of mutual funds, though started with UTI (Unit Trust of India) in 1963, took firm and concrete shape in 1993 with the

government allowing the private sector and foreign institutions to set up mutual funds in India.

According to a Study on the Indian Mutual Fund Industry (IMFI) undertaken by the Associated Chambers of Commerce and Industry of India (ASSOCHAM), it is highlighted that IMFI, which owned assets worth around Rs 5 lakh crore until about September 2007, may end up notching assets of about Rs 6 lakh crore by March 2008, as it has started expanding by penetrating into smaller towns with vigorous speed. According to the ASSOCHAM Study, Asset Under Management (AUM) as percentage of GDP in India is 4.12 percent as against Australia, 88.22 percent; Germany, 10.54 percent; Japan, 7.57 percent; UK, 18.81 percent; USA, 61.27 percent; Canada, 34.33 percent; France, 59.63 percent; Hong Kong, 101.085 percent; and Brazil, 19.95 percent.

Figure 7.1 depicts the growth of this nascent industry in India by tracing the growth of assets of mutual funds.

Figure 7.2 shows the number of mutual fund schemes registered with SEBI.

Though the assets have grown at a fast pace, the Indian mutual fund industry is still in its infancy when compared to developed

84 | H o w t o c h o o s e W i n n i n g s t o c k s

Figure 7.1 growth of Mutual Funds industry in india

Source AMFI booklet on mutual funds, ‘Investor’s Concise Guide’, available at www.amfiindia.com (accessed on 9 December 2009).

Note This fast growing industry is regulated by the Securities and Exchange Board of India (SEBI).

Figure 7.2 Number of Schemes of Mutual Funds

Source AMFI booklet on mutual funds, ‘Investor’s Concise Guide’, available at www.amfiindia.com (accessed on 9 December 2009).

financial markets like USA. As on March 2008, the US mutual fund industry is estimated to be operating with 8,064 mutual funds with an asset base of US$ 11.734 trillion.

M u t u a l F u n d s | 85

Classification of mutual funds into two main categories as open-ended and close-ended schemes by way of structure is the most frequently used classification of funds.

An open-ended fund has the key advantage of offering liquidity, conveniently offering to buy and sell units at net asset value (NAV)-related prices. These funds do not have fixed maturity period. As compared to open-ended funds, close-ended funds have fixed maturity period varying from 2 to 15 years depending on the scheme objectives. One can invest in the scheme at the time of the initial issue and then buy or sell at the stock exchange where it is listed, depending on terms and conditions of issue.

As one gains experience, one can see that the risk exposed when directly investing through the equity route in the market is greater than investing through mutual funds. Mutual funds offer reasonable returns depending on the philosophy of investing and stated practices.

soMe terMs explaIned

As per the definition of AMFI (Association of Mutual Funds of India) website, www.amfiindia.com, the following terms need to be defined for a better understanding.

net asset Value (naV)

NAV is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the valuation date.

sale price

Sale price is the price you pay when you invest in a scheme. Also called Offer Price, it may include a sales load.


repurchase price

Repurchase price is the price at which units under open-ended schemes are repurchased by the mutual fund. Such prices are NAV-related.

redemption price

Redemption price is the price at which close-ended schemes redeem their units on maturity. Such prices are NAV-related.

sales load

Sales load, also called ‘Front-end’ load, is a charge collected by a scheme when it sells the units. Schemes that do not charge a load are called ‘No Load’ schemes.

repurchase or ‘Back-end’ load

Repurchase or ‘Back-end’ load is a charge collected by a scheme when it buys back the units from the unit holders.

The data for Table 7.1 has been extracted and compiled from Diversified Mutual Funds, as reported in Daily MF Performance Alert, around 30 October 2006, as reported in the IDBI Paisa Builder website (daily mutual fund performance indicator excel sheet) and modified in the following manner for the benefit of investors (www.idbipaisabuilder.in):

Data has been analyzed and mutual funds are presented in decreasing order of return from inception/NAV criteria. In Table 7.1, the last column gives the aforementioned values. The justification of the ratio is that it is a measure of return/cost to the individual buyer of the mutual fund and thus is a good indicator of efficiency of management of funds by the fund house.


Among the larger funds size category, Birla Top 100 Fund–Growth and Fidelity Equity Fund–Growth appear promising for investment by this criteria.

Table 7.1 Mutual Fund Schemes in india

Scheme NameFund

Size (Rs crores)

NAV Date NAV

Return Since

Inception (A)

(A)/NAV

Principal Large Cap Fund – Growth

297.44 10/12/2006 15.51 55.1 3.552547

ABN AMRO Opportunities Fund – Growth

138.99 10/12/2006 18.117 56.68 3.128553

Birla Top 100 Fund – Growth

573.99 10/12/2006 14.6797 44.73 3.047065

Fidelity Equity Fund – Growth

2558.64 10/12/2006 18.576 55.23 2.973191

SBI Magnum Multi Cap Fund – Growth

1432.94 10/12/2006 14.46 41.1 2.842324

SBI Magnum COMMA Fund – Growth

573.4 10/12/2006 15.07 42.68 2.832117

Reliance Equity Opportunities Fund – Growth

2029.15 10/12/2006 19.0049 51.97 2.734558

Franklin India Flexi Cap Fund – Growth

3227.64 10/12/2006 19.49 51.21 2.627501

UTI Dividend Yield Fund – Growth

518.27 10/12/2006 15.04 34.47 2.291888

UTI Opportunities Fund – Growth

618.09 10/12/2006 13.99 31.38 2.243031

Kotak Opportunities Fund – Growth

301.1 10/12/2006 25.8 57.37 2.223643

HDFC Core & Satellite Fund – Growth

769.14 10/12/2006 24.39 53.88 2.209102

(Table 7.1 contd )


Standard Chartered Classic Equity Fund – Growth

491.25 10/12/2006 14.0041 30.68 2.190787

ABN AMRO Equity Fund – Growth

211.71 10/12/2006 24.13 52.19 2.162868

Prudential ICICI Discovery Fund – Growth

1209.48 10/12/2006 26.49 56.94 2.14949

Sundaram India Leadership Fund – Growth

300.42 10/12/2006 26.8554 54.25 2.020078

DSP ML Tiger Fund – Growth

1131.3 10/12/2006 28.79 57.22 1.987496

Sahara Wealth Plus Fund - FP – Growth

19.77 10/12/2006 13.2872 26.04 1.959781

Tata Equity P/E Fund – Growth

92.21 10/12/2006 23.1531 44.34 1.915078

Tata Dividend Yield Fund – Growth

191.67 10/12/2006 16.9282 32.16 1.899789

Chola Global Advantage Fund – Growth

23.48 10/12/2006 13.75 24.14 1.755636

PRINCIPAL Dividend Yield Fund – Growth

208.23 10/12/2006 16.05 26.81 1.670405

ING Vysya L.I.O.N Fund – Growth

135.58 10/12/2006 11.9 19 1.596639

Kotak Global India – Growth

126.23 10/12/2006 23.404 37 1.580926

BOB Growth Fund – Growth

13.21 10/12/2006 27.93 39.51 1.414608

Tata Contra Fund – Growth

361.3 10/12/2006 11.634 16.34 1.404504

Canequity Diversified – Growth

86.92 10/12/2006 27.68 38.5 1.390896

Quantum Long-Term Equity Fund – Growth

23.81 10/12/2006 11.5 15 1.304348

(Table 7.1 contd )


Standard Chartered Premier Equity Fund – Growth

218.74 10/12/2006 11.434 13.7 1.198181

Birla Dividend Yield Plus – Growth

579.85 10/12/2006 41.38 47.23 1.141373

DSP ML Top 100 Equity Fund – Growth

282.71 10/12/2006 51.18 57.5 1.123486

DWS Alpha Equity Fund – Growth

162.21 10/12/2006 47.43 51.86 1.093401

Sahara Growth Fund – Growth

6.08 10/12/2006 45 44.02 0.978222

Prudential ICICI Dynamic Plan – Growth

1252.36 10/12/2006 56.5324 55.03 0.973424

HSBC Equity Fund – Growth

1027.94 10/12/2006 63.9265 62.09 0.971272

SBI Magnum Sector Umbrella - Contra – Growth

1316.25 10/12/2006 34.6 33.13 0.957514

ING Vysya Dividend Yield Fund – Growth

101.55 10/12/2006 11.07 10.52 0.950316

Reliance Equity Fund – Growth

5502.32 10/12/2006 10.78 7.8 0.723562

DSP ML Equity Fund 634.6 10/12/2006 40.49 27.75 0.685354

SBI Magnum Equity Fund

258.99 10/12/2006 24.53 16.11 0.656747

PRINCIPAL Growth Fund – Growth

345.52 10/12/2006 46.26 29.26 0.632512

HDFC Growth Fund – Growth

331.39 10/12/2006 44.089 27.6 0.626006

Franklin India Growth Fund

10/12/2006 26.49 16.56 0.625142

Tata Pure Equity Fund – Growth

306.81 10/12/2006 55.7548 34.54 0.619498

DSP ML Opportunities Fund – Growth

1228.59 10/12/2006 50.15 28.6 0.570289

(Table 7.1 contd )


ING Vysya Select Stocks Fund – Growth

50.5 10/12/2006 25.74 13.55 0.526418

UTI Growth & Value Fund – Growth

161.08 10/12/2006 52.1 26.76 0.513628

Kotak 30 – Growth 377.1 10/12/2006 62.154 31.37 0.504714Taurus Starshare 160.36 10/12/2006 35.61 16.57 0.465319

Tata Equity Opportunity Fund – Growth

420.72 10/12/2006 52.3934 24.23 0.462463

ABN AMRO Dividend Yield Fund – Growth

58.49 10/12/2006 10.542 4.84 0.459116

UTI Mastershare – Growth

1851.96 10/12/2006 31.7 13.64 0.430284

UTI Equity Fund – Growth

1521.26 10/12/2006 31 10.92 0.352258

Prudential ICICI Growth Plan – Cumulative

393.67 10/12/2006 85.24 29.6 0.347255

UTI Master Growth – Growth

350.43 10/12/2006 40.95 14.04 0.342857

Templeton India Growth Fund – Growth

332.81 10/12/2006 61.96 21.18 0.341833

SBI Magnum Multiplier Plus 93 – Growth

719.48 10/12/2006 47.51 15.47 0.325616

HDFC Top 200 – Growth

1484.87 10/12/2006 102.098 28.3 0.277185

Franklin India Bluechip – Growth

2419.79 10/12/2006 119.79 31.99 0.267051

Birla SunLife Equity Fund – Growth

405.98 10/12/2006 161.2 40.76 0.252854

HDFC Capital Builder Fund – Growth

790.88 10/12/2006 58.532 14.77 0.252341

JM Emerging Leaders Fund – Growth

57.18 10/12/2006 10.36 2.58 0.249035

(Table 7.1 contd )


Prudential ICICI Power – Growth

1430.63 10/12/2006 73.53 18.03 0.245206

Birla Advantage Fund – Growth

476.94 10/12/2006 113.81 25.24 0.221773

Franklin India Prima Plus – Growth

704.99 10/12/2006 122.72 23.14 0.188559

HDFC Equity Fund – Growth

3498.54 10/12/2006 136.262 24.66 0.180975

Reliance Vision – Growth

1960.26 10/12/2006 163.14 28.84 0.176781

Average 32.38

Source Daily MF Performance Alert at www.idbipaisabuilder.in (extracted on 30 September 2006).

Similarly, the same analysis can be performed for different categories of mutual funds, such as sector funds, mid cap funds, MIP funds, balanced funds, ELSS funds, and so on.

It can be seen that Reliance Growth and Franklin India Prima Fund are doing very well and recommended for further study by this criterion.

Among the balanced funds, using the above approach, analyzing the same reflects the best performing funds. These are organized and sorted out in increasing order of Return/NAV in Table 7.2. Return/NAV is largest for Unit Scheme 2002 growth scheme, BOB Balanced fund growth option is second highest and Kotak Balance Fund is the third best performing fund.

Table 7.2 balanced Funds analyzed

Scheme NameFund

Size (Rs crores)

NAV Date NAVReturnSince

Inception

Return/ NAV

Birla Balance Fund – Growth

133.92 6/1/2006 22.84 13.24 0.5796848

Birla SunLife 95 – Growth

129.23 6/1/2006 147.33 26.85 0.1822439

LIC Balanced – Plan C (Growth)

28.86 6/1/2006 37.0544 7.75 0.2091519

(Table 7.2 contd )


HDFC Prudence Fund – Growth

1688.87 6/1/2006 88.997 21.7 0.2438284

Tata Balanced Fund – Growth

155.81 6/1/2006 41.108 17.55 0.4269242

ING Vysya Balanced Fund – Growth

12.14 6/1/2006 15.83 7.79 0.4921036

DSP ML Balanced Fund – Growth

350.09 6/1/2006 31.23 17.61 0.5638809

PRINCIPAL Balanced Fund – Growth

37.74 6/1/2006 19.67 11.18 0.5683782

Prudential ICICI Balanced – Growth

432.02 6/1/2006 28.7 17.38 0.6055749

FT India Balanced Fund – Growth

237.11 6/1/2006 26.1446 15.99 0.6115986

Franklin India Balanced Fund – Growth

6/1/2006 28.24 17.38 0.6154391

Sundaram Balanced Fund – Growth

42.26 6/1/2006 27.7897 18.47 0.6646347

SBI Magnum Balanced Fund – Growth

218.29 6/1/2006 29.43 20.01 0.6799185

HDFC Balanced Fund – Growth

116.73 6/1/2006 26.458 18.53 0.7003553

Escorts Balanced Fund – Growth

6.28 6/1/2006 39.7222 30.69 0.7726158

JM Balanced – Growth

11.5 6/1/2006 18.87 17.07 0.9046105

Kotak Balance – Growth

106.61 6/1/2006 21.766 22.24 1.0217771

BOB Balance Fund – Growth

1.02 6/1/2006 20.47 30.12 1.4714216

Unit Scheme 2002 – Growth

629.77 6/1/2006 12.36 25.34 2.0501618

Source Daily Performance Alert at www.idbipaisabuilder.in (as extracted on 30 September 2006 and modified to suit the criteria).


If the same criterion is used for mid caps, Table 7.3 recommends the following mutual funds:

SBI Magnum Midcap Growth option ING Vysya bank Midcap Growth option Prudential ICICI Emerging STAR Growth option

Table 7.3 Mid Cap Funds analyzed

Scheme NameFund

Size (Rs crores)

NAV Date NAVReturnSince

Incep tionReturn/NAV

SBI Magnum Mid cap Fund – Growth

532.35 6/1/2006 16.4992 62.18 3.768668

ING Vysya Mid cap Fund – Growth

391.18 6/1/2006 17.64 65.78 3.729025

Prudential ICICI Emerging STAR Fund – Growth

69.85 6/1/2006 15.03 50.13 3.335329

Kotak Mid cap Fund – Growth

785.01 6/1/2006 22.6 66.9 2.960177

SBI Magnum Sector Umbrella - Emerging Businesses – Growth

403.51 6/1/2006 17.207 50.86 2.955774

Sundaram SMILE Fund – Growth

483.38 6/1/2006 25.12 73.14 2.911624

Sahara Mid cap Fund – Growth

292.76 6/1/2006 15.8267 42.73 2.699868

Chola Mid cap Fund – Growth

16.87 6/1/2006 16.1722 40.41 2.498732

UTI Thematic Mid Cap Fund – Growth

61.06 6/1/2006 21.72 53.47 2.461786

Can Emerging Equities – Growth

86.03 6/1/2006 21.51 49.19 2.286843

Tata Mid cap Fund – Growth

21.46 6/1/2006 13.65 30.49 2.2337

Sundaram Select Mid cap – Growth

292.88 6/1/2006 12.2371 22.37 1.828047

(Table 7.3 contd )


SBI Magnum Global Fund 94 – Growth

745.37 6/1/2006 79.1065 71.33 0.901696

Reliance Growth – Growth 692.1 6/1/2006 34.59 15.55 0.449552

Franklin India Prima Fund – Growth

2813.19 6/1/2006 215.11 33.38 0.155176

Source Daily MF Performance Report at www.idbipaisabuilder.in (as extracted on 30 September 2006).

Similar analysis can be done for other categories of mutual funds, if required.

Mutual funds have two broad options—dividend and growth options. The ratio of the NAVs of these two options is one measure of the amount of dividend they have declared from their inception. Therefore, it is better to invest in such funds which have more of this ratio (NAV of growth option/NAV of dividend option). The higher the ratio, the better the performance and the assumption that one can expect the fund to repeat the same performance in future is the basis of investing in the fund. Same level of performance, if continued, can generate dividends in the same proportion. Table 7.4 gives some of the leading funds analyzed in this fashion. Before one understands Table 7.4, one needs to explain the two options—the dividend option and the growth option of mutual funds. Dividend option implies that the fund gives regular cash as dividend or reinvested in the fund as dividend reinvestment option. Please note that when dividend is declared, the NAV comes down by the extent of the dividend amount. This option is preferable for investors who want regular cash at periodic intervals. On the contrary, under the growth option, the declared dividend adds onto your investment and more units are added and investment compounds itself.

Table 7.4 Mutual Funds analysis—Dividend and growth Options

Scheme NAV – Div NAV – Growth Ratio

Sundaram Select Mid cap 14.5 84.62 5.835862

Reliance Growth 46.1 249.99 5.422777

(Table 7.4 contd )


Sundaram Select focus 11.95 54.92 4.595816

Franklin Prima Plus 29.92 133.46 4.460561

HDFC Prudence 26.23 110.32 4.205871

Prudential Tax plan 19.91 82.91 4.164239

Prudential growth 20.76 84.77 4.083333

Franklin Tax shield 30.62 120.91 3.948726

Reliance vision 41.9 164.13 3.917184HDFC Equity 37.84 144.18 3.810254Prudential Power 20.18 74.48 3.690783Franklin Prima 52.51 188.6 3.591697

Franklin Bluechip 35.7 123.86 3.469468

HDFC Top 200 34.83 105.02 3.015217Tata Equ Oppor 18.33 52.44 2.860884JM Income 10.16 28.72 2.826772

HDFC Cap Builder 21.3 59.74 2.804695

Franklin pension 16.51 42.95 2.601454

DSP Top 100 Equity 22.14 55.6 2.511292

Franklin Income 10.48 25.62 2.444656HSBC Equity 28.48 68.72 2.412921HDFC Tax Saver 56.65 134.89 2.381112HDFC LT ADV 37.46 86.04 2.29685JM Equity 15.06 33.51 2.2251

DSP Opportunity 23.84 52.64 2.208054

Reliance Banking 16.93 36.52 2.157118

Source Business Line newspaper.

As one can see, Sundaram Select Mid cap leads all the mutual funds in this analysis. This is one way to analyze and plan investments that are sound and risk free.

Another way to plan your investments is as follows: if you have excess funds from which you want to generate returns that are attractive but at the same time you want to avoid the risks associated with investing in shares, probably you can think of putting the money in fixed deposits with the option of monthly interest being credited to your savings account. This monthly interest can still be invested in Systematic Investment Plans (SIP)


of mutual funds in the aforementioned manner, and thus, the investor protects his/her original investment in fixed deposit and can get further returns by investing in mutual funds also using the interest as option to invest in funds. This ensures that his/her capital is protected and he/she ensures reasonable returns based on his/her investment in mutual funds. To give a simple calculation, say investing in fixed deposit gives a 9 percent return. Reinvesting that interest in an SIP of a mutual fund that gives a return of 20 percent enhances the return to 1.09 × 1.20, which is nothing but 1.308. This means that the investment has the potential to appreciate and give 30 percent return by safeguarding your original investment in fixed deposit. The principal is thus safe but you have been able to capitalize and improve your returns by such multiple investments and proper routing of investments. Similarly, if you have made profits in equity investing and are thinking of booking the same, you can book it and invest in fixed deposits to safeguard, or invest in debt instruments in mutual funds such as income schemes, so that the money rotates and your assets can grow at a faster pace.

8Unconventional Ratios for

Identifying Stocks

O ne comparison is to shortlist the companies that have returns greater than P/E ratio and then analyze them for identifying

value in buying them. The following data is analyzed to identify companies for investment based on details in Business Standard dated 21 September 2006. The premise is to invest in com panies that have high ratio of ROCE to P/E ratio as they are better companies to place your bets on in the uncertain market. This ratio gives a clue to which companies are better placed for further investment.

Table 8.1 ROCe vs P/e Ratio of Select Companies

Company RoCe P/e RoCe/P/e

SAIL 62.58 5.56 11.26

Sesa Goa 93.23 10.53 8.85

GTC 223.18 26.56 8.40

SCI 24.74 3.64 6.80

Tata Steel 56.02 9.9 5.66

Harrisons Malayalam 18.55 3.67 5.05

JSW Steel 28.99 5.75 5.04

KEC Infra 17.48 3.5 4.99

IPCL 30.28 7.05 4.30

Gujarat Alkalies 30.42 7.7 3.95

Dhampur Sugar 23.59 6 3.93

(Table 8.1 contd )


GE Shipping 21.49 5.59 3.84

Hero Honda 71.92 19.09 3.77

Nalco 41.41 13.35 3.10

Glaxo 70.09 23.69 2.96

GNFC 24.71 8.5 2.91

GAIL 28.29 10.31 2.74

ONGC 34.71 14.49 2.40

BEL 43.56 18.86 2.31

HCL Info 30.28 13.79 2.20

Jindal Stainless 19.24 8.77 2.19

HPCL 17.59 8.42 2.09

TCS 70.04 33.76 2.07

Escorts 15.41 7.95 1.94

Colgate 70.66 40.54 1.74

HUL 72.88 45.02 1.62

Hinduja TMT 15.25 9.48 1.61

Satyam 33.38 21.87 1.53

Dwarikesh 18.82 13.45 1.40

Indian Oil 15.1 11.42 1.32

Maruti 28.51 22.26 1.28

Grasim 23.95 18.88 1.27

Triveni Engg. 25.08 20.29 1.24

BOC India 17.12 14.08 1.22

BEML 33.92 28.15 1.20

Mangalam Cement 18.78 15.64 1.20

Hind zinc 35.06 29.23 1.20

ITC 39.19 34.03 1.15

Reliance 18.66 16.45 1.13

Infosys 39.68 36.38 1.09

Tata Motors 28.34 26.9 1.05

Aftek Infosys 13.37 12.72 1.05

Dabur India 43.04 41.09 1.05

Source Business Standard, 21 September 2006.

U n c o n v e n t i o n a l R a t i o s f o r I d e n t i f y i n g S t o c k s | 99

From the Table 8.1 we can see that companies like (a) SAIL, (b) Sesa Goa, (c) GTC, (d ) SCI, and (e) Tata Steel have value in buying them as per the logic discussed. This is one indicator of trying to assess which companies are attractively placed for investment.

Table 8.2 analyzes the sales growth rates of companies along with their P/E ratios. One can then try to identify by the ratio of growth to P/E ratio those companies that are available at cheaper valuations but simultaneously have high growth rates. This ratio gives dispassionate judgment of ratio of growth rates to P/E ratio and objectively identifies companies that are better placed. The premise to follow is that the higher the ratio, the better it is to invest in that company.

Table 8.2 Growth Rates Data of Select Companies

Company MCAP SalesGrowth

RateP/e

Growth Rate/P/e

HCL Tech 13322 1447 99 22.7 4.361233Hindalco 17629 3657 45 10.7 4.205607Glaxo 8240 1470 55 14.8 3.716216ICICI 44479 18767 54 17.5 3.085714Jet 5217 5693 35 11.5 3.043478Nalco 13112 4888 25 8.4 2.97619Cipla 15417 2985 63 25.7 2.451362Wipro 59952 10247 69 29.7 2.323232Tata Power 8508 3942 31 13.9 2.230216HDFC Bank 21600 5689 55 24.9 2.208835Satyam 19546 4634 32 15.6 2.051282

Gujarat Ambuja Cements

11865 2600 39 19.6 1.989796

BHEL 42178 9516 45 25.1 1.792829Tata Chem. 4232 2982 21 12 1.75M&M 12861 6509 25 15.2 1.644737PNB 11469 11092 13 8 1.625Tata Motors 27583 20602 29 18 1.611111TCS 80632 11230 45 29.7 1.515152Bajaj Auto 24040 7668 33 21.8 1.513761

(Table 8.2 contd )


Oriental 3897 4676 10 7 1.428571VSNL 8725 3303 16 11.4 1.403509HPCL 7898 71037 27 19.5 1.384615HDFC 27692 4278 30 22 1.363636ITC 55450 9790 28 24.8 1.129032ACC 13093 3160 19 17 1.117647Hero Honda 14696 7418 16 15.1 1.059603Tata Steel 23525 15139 7 6.7 1.044776Sun Pharma 12646 1215 28 27.4 1.021898Infosys 74225 9028 31 30.7 1.009772SBI 40441 43183 8 9.2 0.869565ABB 9325 2963 32 38.5 0.831169Tata Tea 3599 886 16 19.3 0.829016Dr Reddys 9082 1550 29 43 0.674419Grasim 14430 6655 11 16.7 0.658683BPCL 9540 72395 34 73.4 0.463215Maruti 20747 12052 8 17.5 0.457143HUL 45091 11080 12 28.2 0.425532Zee 8873 834 50 120.1 0.41632ONGC 136811 46366 3 9 0.333333L&T 25858 14763 8 25.8 0.310078Dabur 6440 1369 6 34 0.176471GAIL 18575 14459 1 8 0.125Ranbaxy 12764 3408 2 62 0.032258SCI 3587 3396 0 2.8 0SAIL 26455 28778 –2 6.6 –0.30303MTNL 9025 5249 –7 15.6 –0.44872Bharti 62245 11228 –59 30.9 –1.90939Reliance Energy 8009 3976 –29 12.3 –2.35772IPCL 5378 8469 –13 5.4 –2.40741

Source Business Standard and Capital Market magazines.

The following companies can be looked at for further investment opportunities:

HCL Technologies Hindalco Glaxo Pharma

U n c o n v e n t i o n a l R a t i o s f o r I d e n t i f y i n g S t o c k s | 101

ICICI Bank Jet Airways Reliance Nalco Cipla Wipro Tata Power HDFC Bank Satyam

ASSUMPTIONS BEHIND THE USE Of RATIOS DISCUSSED fOR INVESTMENT DECISIONS

The one thing that needs to be ascertained is whether these growth rates, ROCE, and so on, achieved by the companies are likely to be sustained in the ensuing years and whether these companies have sustainable business models or not. These criteria are only a first screener to identify the attractiveness of a stock to be invested in. Usual profitability analysis needs to be coupled with the above approach to yield better and consistent results. If one’s analysis identifies a company that is also recommended by another research firm in the securities market, then one knows that one is on the right track. What is needed is to keep a sharp eye on the market and visit as many websites of investment firms as possible and update one’s investment research with that of the firm and proceed further with decisions. The unusual ratios presented in this chapter cannot give target prices for investments but only act as a filtering agent for identifying companies and listing them for future analysis and monitoring for investments.

9General Suggestions Compiled

from the Available Literature

Whenever inflation rate is higher than interest rates, there will be pressure for interest rates to rise. When inflation rate is lower,

then interest rates may remain stable barring other considerations of law of supply and demand applicable in money markets.

Some hints which are compiled from reading various books on investment and also those pitfalls which should be avoided, for the benefit of readers, are summarized as follows:

Invest in companies that have dividend yield of more than half the savings bank interest rate.

If you are an investor, you should learn to keep pace with current events and their implications on stocks. This single most reason can distinguish between a successful investor and an unsuccessful one.

Invest in companies that have net profit margin more than twice the bank interest rate.

For those companies that have higher ROCE, you can expect them to have higher MCAP/Sales ratio of 3 or more.

One should invest only in companies that are growing at a rate equal to inflation + interest rate.

Avoid companies that have ROE of less than 12 percent. One should be changing the criteria smartly depending on

stock market conditions. Remember that high P/E companies will decline faster in a

bear market.

G e n e r a l S u g g e s t i o n s | 103

Sell off low dividend yield company stocks in a bear market to avoid further losses.

Avoid companies wherein the ratio of earnings yield to dividend yield is more than 3.

One of the reasons why some stocks keep going up and the reasons advocated on TV is the value of real estate owned by the company. If this value per share owned is more than the share price of the company, then it is automatically a candidate for fresh investments and someone will surely discover its value and then the upward journey for the stock starts. One should ensure that these real estates are not owned by resorting to undue borrowings by the company. This analysis is not reflected in the balance sheet or the P&L account of the company and needs to be gathered by studying the company in great detail.

One needs to be careful about investing into cyclical products (copper, aluminum, steel, autos, paper, and so on) by looking at price to earnings ratio (which may be cheap). One should carefully study the cycle of the industry and only then invest into them. Investing in cyclicals when in a recession has proved to be better than when the economy recovers.

If a stock disappoints with results in a quarter, immediately sell it as it would take a quarter to fix it. Though this book advises investing for long term, it is always prudent to keep checking and reviewing the prospects every quarter about the assumptions behind your investment decision. Whether there has been a fundamental change in the scenario is the question that one needs to determine before taking further decisions on the portfolio. One should verify if the stock is attractively priced relative to its earnings and also verify if the earnings of the company are going up or not. After verifying the facts, one can decide if the prospects have improved, and only then one may think of increasing one’s holding. In case the prospects have worsened, then one can think of moving into another stock or reducing one’s holding. Alternately, if the company is stable, then one can


decide whether one wants to stick on with one’s investment considering other alternate opportunities for one’s money.

Generally, as these approaches are followed, one will identify a plethora of stocks for investment as creativity is the root of successful investing value wise. One can decide to hold on if long-term implications are there in these identified stocks, and periodical monitoring of fundamentals to check whether they are in place or not is essential for realizing better returns. However, it is difficult to predict at what price to sell the stock, as there are many factors which affect a stock price of the particular company you have invested in. Therefore, it is better to adopt the strategy of ‘a bird in hand is better than two in the bush’ and keep periodically booking profits after you have invested, depending on your actual needs. Keeping a target profit in mind and then selling off or rotating your money may be a better option.

If you want to invest in small caps, invest only after they turn in the profits. Do not invest in anticipation of profits.

None can predict the movement of interest rates, future of economy, or stock market. Instead focus on your investments and their businesses and what is happening to them. Keep reading a great deal about the businesses you have invested in.

One should learn to study companies and their prospects from all the available information one can gather. If one studies these parameters as described in the book, one may master the science of investment; otherwise it will be like a game of poker for the investor and his/her returns. In case one does not have the time to do the homework suggested for companies, then one can turn into investing in mutual funds.

One should learn to avoid the pitfall of buying a company with cheap valuation but mediocre prospects. This is a sure way to lose money. Therefore, one should learn to analyze the prospects of the business one is likely to invest in.

Periodical checkup and screening on a quarterly basis identifies which companies have to be pruned and which


companies have to be rotated for investments and this definitely improves one’s results. One should be careful and not get attached to stocks emotionally when prices are beyond the line of reality; one should sell it and come out. Stock market is a place of immense potential for alternatives to exist and this should be capitalized. One should be careful to learn from mistakes and avoid repeating the same by keeping a cool head and good temperament.

Remember that in the stock market, the profit in hand is worth twice the profit in the bush. This helps you to book profits at reasonable periods of time to stay afloat in the market.

Remember that the art of investment teaches that a bargain P/E ratio of Tata Steel is not the same as bargain P/E ratio for Reliance Industries. They are different and learning to judge this intricacy is the key to successful investing.

Remember the thumb rule that a company with its P/E ratio at half its earnings growth rate is worth looking at for investment and those companies wherein the P/E ratio is twice its earnings growth rate are candidates for disinvestment.

It is always better to read carefully the annual reports of the company you plan to invest in for important indicators like the cash position of the company, net of debt as well as value of its subsidiaries and other related group companies. You may be able to discover that the company may be available for a bargain and is undervalued so that the market discovers the same and share price then shoots up.

Peter Lynch in his book One Up on Wall Street recommends analyzing a company on the following lines. If a company’s long-term growth rate is 20 percent and the dividend yield is 5 percent, we need to add both of them and then divide the sum by actual P/E ratio of the company. He suggests that if this ratio is <1, the company is a poor candidate for investment; if the ratio is +1.5, the company is okay for investment; and a ratio of >2 means that the company is a potential candidate for investment.


Table 9.1 enlists some important points to note about Bull and Bear phases of a stock market.

Table 9.1 bull Market vs bear Market

Bull Market Bear Market

Bull markets tend to last longer. Greater amount of losses in a short timeframe is the hallmark of the bear market. For example, the January 2008 crash of Indian markets and the market behavior in the subsequent months.

High P/E ratio and low dividend yields characterize this phase.

Falling P/E ratio is the hallmark and high dividend yields are common.

Generally, prices are going up. Generally, prices keep going down even after good news flows in.

Volume of shares traded is high. Volume of shares trades is low.

Number of companies raising capital through public route is high.

Companies are afraid to raise capital in the public domain due to adverse market sentiment.

Generally, economy is on a recovery mood or in boom and all indices show positive growth signs. Investor psychology is upbeat.

Generally, accompanied by slowdown of economy, rising unemployment, rising inflation, and so on.

In a bull market, there is less supply of securities and high demand for the stocks. This results in a rising trend of the prices in the market due to imbalance in supply–demand equation. As a result, share prices soar as investors compete to buy the available equity.

In contrast, a bear market has more sellers and lesser number of buyers.

Source Author.

ADDITIONAL BOOKS TO READ TO MASTER THE ART OF INVESTMENT

The readers of this book are further advised to read the following bestsellers on investments to understand the market better and thus hone their skill set. Some of the books are easy to read while


some are complex and require in-depth study; a cursory glance is not enough to pick up the finer points or logic of investments.

Graham, Benjamin. 1949. The Intelligent Investor. New York: Collins.

Graham and Dodd. 2008. Security Analysis: Principles and Technique, 6E. New Jersey: McGraw-Hill Professional.

Lynch, Peter. 1989. One Up on Wall Street: How to Use What You Already Know to Make Money in the Market. New York: Simon & Schuster.

Lynch, Peter. 1993. Beating the Street. New York: Simon & Schuster.

Murphy, Joseph E Jr. 1994. Stock Market Probability, 2nd edition. New Jersey: McGraw Hill.

Pardoe, James. 2005. How Buffett Does It. New Jersey: McGrawHill.

Train, John. 2003. The Midas Touch: The Strategies that Have Made Warren Buffett the World’s Most Successful Investor. Hampshire: Harriman House Classics.

Lefevre, Edward. 2006. Reminiscences of a Stock Operator, Revised Edition. New Jersey: John Wiley and Sons.

Fischer, Kenneth L. 1990. Super Stocks. New Jersey: McGraw Hill.

Fischer, Philip A. 1996. Common Stocks and Uncommon Trends. New Jersey: John Wiley and Sons.

O’Neill, William, J. 2002. How to Make Money in Stocks: A Winning System in Good Times Or Bad. New Jersey: McGraw-Hill.

Cawkwell, Simon. 1995. Profit of the Plunge: How to Win at Short Selling. Leighton Buzzard: Rushmere Wynn.

It is advisable to pay our respects to investors who have practiced the Ben Graham theory of value investing. Some of them who practice the value investing philosophy at leading firms (like Franklin Templeton) are:

William J. Ruane Irving Kahn Charles Brandes


Charlie Munger Mario Gabelli Prof. Roger Murray Max Heine Micheal F. Price Seth Klarman Martin J. Whitman Joel Greenblatt Charles de Vaulx Jean-Marie Eveillard

Some of the aforementioned have worked for reputed mutual funds and have established such well known performance standards that are the envy of stock market pundits.

Finally, this book pays respects to all those who have mastered the art of investment with their unconventional thinking and created wealth.

I n d e x

Abbott, 54annual report, 9, 64, 105assets per share model, for investment

analysis, 56–60Associated Chambers of Commerce

and Industry of India (ASSOCHAM), 83

Association of Mutual Funds of India (AMFI), 85

Bajaj Hindustan, 20, 23–25balance sheet of company, 10–11BHEL, 51, 52BOB Balanced fund growth, 91, 92Buffett, Warren, 2–8, 17, 55bull and bear phases, of stock market,

106Business Standard, 17, 19, 40, 61, 64,

65, 81, 97

Capital Market, 17, 55, 56, 66, 68, 70, 79, 80

cash earnings per share (CPS) model, 55–56

cash flow statement, 11–12cyclical products, investment in, 103

debt employed by company, assessment of, 64–65

capital employed/net worth, formula for, 61

identification of company with less debt, data for, 61–64

investment in company with low debt content, 64

debt–equity ratio, 11, 64dividend payout, 14dividend yield, 13–14Dogs of Dow theory, 38–39

earnings per share (EPS), 10, 14, 49companies with high sales per

share, 51–52drivers of, 49Nifty group of companies, analysis

for, 50–51volatility in, 49

EBIDT, 10

Foreign Institutional Investor (FII), 81Franklin India Prima Fund, 91

GAIL, 37Glaxo Pharma, 44Graham, Benjamin, 2, 4, 6, 107

How Buffett Does It: 24 Simple Investing Strategies from the World’s Greatest Value Investor, 4

How the Stock Market Works: A Beginners Guide to Investment, 7

Indian Mutual Fund Industry (IMFI), 83

Infosys, 44


ING Vysya Mid cap Fund, 93investors, guidelines for, 16–17,

102–105bestsellers books, on investments,

106–107P/E ratio of company, formula for

prediction of, 18application of formula, 18–19data analysis for various

companies, example of, 20–25

Kotak Balance Fund, 91, 92

management, evaluation of quality of, 13

margin of safety, 4market capitalization (MCAP), 15. see

also valuation ratios, related to market capitalization

MCAP/Sales ratio, 15, 27, 29–35, 38, 45, 53, 54, 73, 80, 102

Mphasis BFL, 20, 23, 24mutual funds, 83, 85

balanced funds, analysis of, 91–92classification of, 85data on mutual fund schemes,

analysis of, 86–91definition of, common terms

net asset value (NAV), 85redemption price, 86repurchase or back-end load, 86repurchase price, 86sale price, 85sales load, 86

dividend vs. growth option, 94analysis of, 94–95

growth of mutual fund industry in India, 84

mid caps funds, analysis of, 93–94number of mutual fund schemes, 84open-ended vs.close-ended funds, 85SIP of, 95–96

Nalco, 38

net profit margin (NPM), 10, 28, 30, 34–38, 49–52, 54

Novartis, 54

O’Higgins, Micheal, 39One Up on Wall Street, 105ONGC, 36, 41operating profit margin (OPM), 66,

81analysis of key sectors, 73–78

OPM margins in current quarter, identification of company on, 66

Pardoe, James, 4pharma companies, dividend yield

and MCAP/Sales model for, 52ET-Lifex basket of companies,

analysis of, 53–54identification of companies for

investment, approach for, 54, 55

price to earnings ratio (P/E ratio), 15Profit and Loss (P&L) statement, 9–10Prudential ICICI Emerging STAR

Fund, 93

quarter results, investment decision on, 103–105

ratio analysis, 12–13ratios for investments, use of, 97, 101

growth rates to P/E ratio, ratio of, 99–101

growth rates data of companies, 99–100

ROCE vs P/E ratio, 97data of selected companies,

97–99real estate owned by company, value

of, 103Reliance Growth Fund, 91Reliance Industries, 51, 52return on capital employed (ROCE),

12, 16, 39–44return on equity (ROE), 12Ruchi Soya, 48

I n d e x | 111

Satyam Computers, 13SBI, 51, 52SBI Magnum Mid cap Fund, 93sector-wise analysis, for investment,

70companies in key sectors, number

of, 70–73FII holdings in companies,

monitoring of, 81–82variation in FII holdings status,

82identification of companies, 79–80OPM analysis, of key sectors,

73–78parameters to judge overall

heatedness of stock market, 80–81

profitability, sectors with improved, 79

Security Analysis, 3stock markets

driving forces of, 2investments in, 1–3investors, objectives of, 3temperament required in, 8terms commonly used in, 9–13

capital employed, 16dividend payout, 14dividend yield, 13–14earnings per share, 14MCAP to sales ratio, 15MCAP/Assets, 15–16price to earnings ratio, 15return on capital employed

(ROCE), 16trends in long run, 7–8value-based philosophy,

investment on, 3–7Sundaram Select Mid cap, 94, 95

Systematic Investment Plans (SIP), 95–96

Tata Steel, 20, 23, 24, 32, 34–36, 40, 41, 44, 48, 50, 63, 97, 99, 105

TCS, 44tea sector, 70, 73, 79

Unit Scheme 2002 growth scheme, 91, 92

Unit Trust of India (UTI), 83

valuation ratios, related to market capitalization, 26

MCAP/ Assets ratio, 44–48MCAP/Capital employed, 39–40,

44bubble charts, for identification of

companies, 41–44data on selected companies, 40–41risk assessment of investments, by

ROCE approach, 39MCAP/Sales ratio, 26, 38–39analysis of scenarios of, 27bubble chart, for companies

identification, 35–38companies sorted out on basis of,

30–33competing companies, comparison

of, 38decision to exit stock, 29investment decisions, basis of,

28–29Nifty basket of companies and,

34–35use of, formula for, 26–28

value investing, 3–7, 107–108value investor, 4

A b o u t t h e A u t h o r

G.B.R.K. Prasad is working as Associate Director, Capital Goods Sourcing Team, at Dr Reddy’s Laboratories Limited, Hyderabad, Andhra Pradesh, India. He is a graduate in mechanical engineering from the Indian Institute of Technology, New Delhi and did his MBA (Finance) from Jamnalal Bajaj Institute of Management Studies, Mumbai. He has 25 years of experience in the Indian corporate sector. He has varied industrial experience across verticals such as automobiles, pharmaceuticals, and so on, along with a brief stint in academics. Dr Prasad did his PhD in Supply Chain Management from Osmania University, Hyderabad and completed Certified in Production and Inventory Management (CPIM) certification from Advancing Productivity, Innovation, and Competitive Success (APICS), USA in 2003. He was made fellow member of APICS with the title Certified Fellow in Production and Inventory Management (CFPIM) in January 2009.

He has written several articles on varied topics on Management in The Hindu Business Line, Hindustan Times, Pharma Bio World, Express Pharma, Indian Management, The Chartered Accountant Student, Materials Management Review, and so on. He has authored a book titled Corporate Performance Improvement: A Practitioner’s Perspective, which describes a unique approach at improving return on assets of any company.

His hobbies are investing in stock markets and doing data analysis. Identifying companies for investment with fundamental analysis is his forte. He can be reached at [email protected].

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